On December 22, 2017, President Donald Trump signed into law the largest overhaul of the nation’s tax code since 1986, known as the Tax Cuts and Jobs Act (TCJA). While the reduction in the corporate income tax rate from 35% to 21% grabbed most of the headlines, there are several important considerations related to the TCJA that both tax attorneys and non-tax attorneys alike should be aware of as they plan for Q3 and Q4 2018 and beyond.
The TCJA is a detailed piece of legislation (it is 185 pages of fine print) with numerous technical terms and related forgettable acronyms. Even without a comprehensive understanding of the law though, all attorneys can serve their employers and clients more effectively by being aware of the important state and local tax (SALT) implications of tax reform, such as how states will conform to the TCJA, how the TCJA impacts development incentives for state and local governments, and the challenges and opportunities the TCJA presents for federal tax planning purposes.
State tax conformity
Because the TCJA reforms the federal tax code, the threshold question for SALT purposes is the extent to which a state conforms to the Internal Revenue Code. If a state does not conform as of December 22, 2017, then the Internal Revenue Code provisions in the TCJA will not apply at the state level, and there will be less of an impact on state taxation. On the other hand, if a state conforms to the Internal Revenue Code as amended by the TCJA, then taxpayers can expect a substantial impact on their state tax obligations. Many states anticipate that conforming their tax codes to the post-TCJA Internal Revenue Code will increase state tax revenue because the TCJA expands the tax base for states, but the corresponding rate reduction in the TCJA will not automatically be adopted by the states.1 Some states are beginning to respond to the TCJA with legislation that conforms to certain provisions, while excluding others.
For example, in 2018, Idaho enacted a law that generally conforms to the Internal Revenue Code as of December 21, 2017, but selected two provisions as to which it will conform as of December 31, 2017.2 One of the TCJA provisions adopted by Idaho adds certain earnings of foreign subsidiaries of US companies into the tax base. However, Idaho did not adopt the corresponding deduction from the TCJA. As a result, Idaho is like a child on Thanksgiving eating all the marshmallows off the top of the yams; the state takes the good part of the TCJA that increases the state tax base but leaves the deductions behind.
Other states are really getting into the weeds with their conformity bills by selecting individual sections, subsections, and sub-provisions of the Internal Revenue Code with which they will conform based on the political climate and the influence of certain industries in the state, among other factors.3 Still, other states keep it simple and take the good with the bad by simply conforming to the Internal Revenue Code as of the end of 2017.4
Why state tax conformity matters to non-tax attorneys?
Generally, Internal Revenue Code conformity legislation is not controversial and is often just a formality. In 2018 though, this will not be the case, and states have the opportunity to shape how federal tax reform will impact their taxpayers’ obligations in each state. Non-tax lawyers should coordinate with their policy departments or lobbyists to identify these opportunities and potential threats regarding the impacts on their employers and their specific departments. For example, the TCJA eliminates or suspends the tax deduction for certain benefits previously offered to employees such as an employer’s reimbursement of an employee’s bicycle transportation expenses. Human Resource Department attorneys should be aware of these modifications and think about whether it might make sense to protect these benefits at the state level by coordinating a lobbying effort related to a state’s conformity legislation. More information and insights on employee benefits are available from Eversheds Sutherland attorneys online at: https://www. taxreformlaw.com/category/employee-benefits/.
Disincentivizing incentives from state and local governments
Under the TCJA, many incentives offered by state and local governments to corporate taxpayers may be considered part of the corporation’s taxable gross income for federal income tax purposes. In other words, the value of benefits offered to businesses by state and local governments for investing in a state or community may be included in the company’s tax base subject to federal income tax. As a result, cash grants, no-cost land or equipment, public infrastructure and improvements, or other similar transfers of money or property to a corporation from a governmental entity may be subject to tax under the TCJA if taxpayers do not take the proper precautionary measures.
This modification is important because state and local governments often offer a wide variety of incentives to a business willing to invest in the state or locality. For example, Connecticut’s “First Five Plus Program” provides cash grants to taxpayers undertaking projects that create at least 200 new jobs and invest at least $25 million in the state. However, under the TCJA, contributions of money or property to a corporation by a governmental entity will generally be includible in gross income. Thus, to the extent a taxpayer receives a cash grant under this program, the grant would be included in the taxpayer’s tax base, and the taxpayer would have to pay tax on it.
This is a dramatic change from prior law, which encouraged state and local governments to offer these incentives by excluding “any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such)” from a corporation’s tax base.
Why incentives matter to non-tax attorneys?
All attorneys should be concerned with the bottom line of their employers or clients, and the taxability of incentives offered by state and local governments significantly impacts a corporation’s bottom line. Non-tax attorneys, especially those involved in business planning decisions and construction projects in any capacity, should be aware that an incentive might not actually be that much of an incentive if the incentive increases the corporation’s tax obligations too much. There are opportunities to minimize the federal tax impact while maintaining the same net economic benefit of most incentives though, and attorneys should work with experts to properly structure these arrangements.
In addition to the impact of the TCJA on SALT planning, there are a number of issues that should be considered to address the broad-sweeping ramifications of federal tax reform. As previously mentioned, the corporate tax rate was reduced from 35% to 21% for years beginning after December 31, 2017. To fully take advantage of this permanent rate reduction, taxpayers should evaluate their treatment of all items of income and expense to ensure they are utilizing the most favorable available accounting methods to accelerate deductions into 2017 to reduce their taxable income in the last year taxed at the 35% rate, while concurrently deferring income into 2018 and beyond, which will be taxed at the reduced 21% rate.
A number of taxpayer-favorable accounting method changes that are available on an automatic basis include changes involving the treatment of tangible property (i.e., how a company treats materials and supplies, what constitutes a repair, when a partial disposition of an asset has occurred), depreciation, customer rebates and allowances, accrued compensation, and deducting prepaid liabilities. By adopting certain accounting methods, companies will be able to use those changes to produce a permanent tax benefit due to the corporate tax rate change. This permanent difference will have an immediate and direct impact on a company’s bottom line for not only 2017, but also for 2018 and beyond.
Beyond accounting for the reduced corporate tax rate, companies should also fully understand the implications of the full expensing provisions of the TCJA. The full expensing provisions of the TCJA expanded existing bonus depreciation to 100%, permitting a full deduction of the cost of “qualified property” acquired and placed in service after September 27, 2017, and before January 1, 2023. Companies will want to review all acquisitions between September 27, 2017, and December 31, 2017, to confirm that any acquired property is considered qualified property available for full expensing during this small window, when the benefit of full expensing is exacerbated when the 35% corporate tax rate for 2017 overlaps with the full expensing provision. Because the TCJA allows companies to take advantage of the bonus depreciation for any property acquired by year-end, there may be an ability to carry back the related net operating losses to prior tax years, file a carryback claim, and obtain an immediate cash refund.
Additionally, the new provision also expanded the definition of qualified property to include used property. No longer will companies receive the benefit of bonus depreciation only upon the acquisition of new property. Due to these revisions, companies will now have to think twice about structuring deals as stock or asset acquisitions to take full advantage of the significantly broader full expensing provisions.
Many tax experts are just beginning to understand the implications of the TCJA, and this article only scratches the surface. The critical takeaway is that the TCJA includes provisions that reach many facets of a corporation’s business, and taxpayers should consider the potential opportunities and challenges presented by the TCJA in 2018 and beyond.