Workshop J Major Emerging State & Local Tax Issues Arising from - - PDF document

28th Annual

Tuesday & Wednesday, January 29‐30, 2019

Hya Regency Columbus, Columbus, Ohio

Workshop J

Major Emerging State & Local Tax Issues Arising from Federal Tax Reform

Tuesday, January 29, 2019 3:00 p.m. to 4:00 p.m.

Biographical Information Diann L. Smith, Counsel, McDermott Will & Emery 500 N. Capitol St. NW Washington, DC 20001 dlsmith@mwe.com 202.756.8241 Fax 202.756.8087 Diann Smith is counsel in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office. Diann focuses her practice on state and local taxation with an emphasis

• n tax challenges relating to compliance, controversy, planning and legislative activity. Diann has

experience representing clients in nexus, tax base, business and non-business income classification, apportionment and FIN 48 compliance issues. She has also counseled clients on multi-state unclaimed property compliance and voluntary disclosure opportunities. Diann has represented clients from a broad range of industries, including retail, insurance and communications services. Diann has significant experience representing clients before the Multistate Tax Commission (MTC). Prior to joining McDermott, Diann was counsel at another international law firm, where she also focused on state and local taxation. She also previously served as general counsel for the Council

• n State Taxation (COST). While at COST, Diann worked on nearly every major state and local

tax issue confronting multi-state businesses. From 1998 to 2005, Diann was an adjunct professor at Georgetown University Law Center for the LL.M. in taxation program. Diann received her J.D. from the Georgetown University Law Center, where she was an editor of the Georgetown Law Journal. She received her B.A. from Miami University. Diann served as a law clerk to the Honorable Alan E. Norris of the U.S. Court of Appeals for the Sixth Circuit in 1991 and 1992. Diann is admitted to practice in the District of Columbia, Ohio and New York. Nikki E. Dobay, Senior Tax Counsel, Council on State Taxation (COST) 122 C Street NW Ste. 330, Washington, DC 20001-2109 (202) 484-5221 NDobay@cost.org Nikki E. Dobay is Senior Tax Counsel of the Council on State Taxation (COST). COST, with a membership of nearly 600 multistate corporations, is dedicated to preserving and promoting equitable and nondiscriminatory state taxation of multi-jurisdictional entities. Prior to joining COST, Nikki was Manager at PwC, where she focused on state and local tax matters. Nikki consults on sophisticated Oregon state and local income matters, multistate tax issues, consequences and planning opportunities related to corporate M&A transactions, and has experience consulting and advising on multistate income, excise and property tax incentives related to renewable energy

• projects. Nikki assists with Oregon tax controversy matters, including audits and proceedings in

the Oregon Tax Court. In addition, she represented taxpayers in negotiations with the Oregon Department of Revenue and City Revenue Bureau, which administers the Multnomah County and Portland City Business Taxes. As a member of the Oregon State Bar Laws Committee, Nikki monitors and provides comments on Oregon state tax legislation and regulations. Prior to working at PwC, Nikki was an associate at Stoel Rives where she focused on international, federal and state and local tax matters. Specifically, Nikki consulted and advised on a variety of federal income and excise tax matters relating to corporate M&A transactions, partnership formation, renewable and other energy related transactions and assisted with tax controversy work.

Biographical Information Ian E. Boccaccio, Principal and Income Tax Practice Leader Ryan, LLC, Three Galleria Tower, 13155 Noel Road, Dallas, TX 75240 469.399.4545 Fax: 972.960.0613 Ian.Boccaccio@ryan.com Ian Boccaccio is a Principal and Income Tax Practice Leader at Ryan, responsible for leading a global service team of highly skilled professionals coupled with cutting-edge technologies to make substantive and long-term differences to an organization’s profitability. Prior to Ryan, Ian was a Partner at a global tax and business advisory services firm in New York, NY. Ian has extensive experience in servicing the income tax needs of the most complicated organizations in the world. In addition to his experience earned over twenty years of practice, Ian has taught these specialized areas of taxation at various seminars around the world. Ian has spent much of the past few years assisting his clients in readying the organization for US Tax Reform. In addition to serving his clients, Ian has been a consistent thought leader on US Tax Reform, through both industry seminars, as well as in written publication. Recent publications include: October 26, 2017 – “What’s That Thumping? The Repatriation Boogeyman is Back!” published by Global Tax Weekly; February 23, 2017 – “The Repatriation Boogeyman” published by Global Tax Weekly; March 24, 2016 – “Repatriation Readiness: Now is the Time” published by Global Tax Weekly; and October 15, 2015 – “A Blind Spot for CFOs: How Global Companies Can Successfully Address Threats to Withholding Tax Compliance” published by Global Tax Weekly

Major Emerging State & Local Tax Issues Arising from Federal Tax Reform (Tax Cut & Jobs Act of 2017)

28th Annual Ohio Tax Conference January 29, 2019

Nikki Dobay, Senior Tax Counsel, Council On State Taxation Diann Smith, Counsel, McDermott Will & Emery Ian Boccaccio, Principal & Income Tax Practice Leader, Ryan LLC

Agenda

– Overview of State Tax Conformity with the Tax Cuts and Jobs Act – Key International Tax Provisions Impacting the States – Key Domestic Corporate Tax Issues Impacting the States

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Overview of State Tax Conformity with the Tax Cuts and Jobs Act

Key Tax Law Changes in the TCJA and Differences from the Tax Reform Act of 1986

– Revenue Neutral vs. Deficit Financed

• The Tax Reform Act of 1986 provided for about $120 billion of PIT cuts

financed by about $120 billion of CIT increases.

• The Tax Cuts and Jobs Act (P.L. 115-97) (TCJA) provides for $6 trillion
• ver 10 years of tax cuts and only $4.5 trillion over 10 years of tax

increases.

– Transformational Changes

• 40 percent corporate tax rate cut to sync up with OECD norms.
• Lower PIT rate – and pass-through deduction for individuals.
• Broad new limitations on the interest deductions.
• Bonus depreciation and immediate expensing.
• $10k limitation on state and local tax deductions for individuals.

– International Tax Reform

• Moves the U.S. from a worldwide to a quasi-territorial tax system

consistent with U.S. trading partners.

• New foreign source tax provisions intended to raise revenues (to offset

tax cuts) and tilt the playing field to favor domestic commerce over foreign commerce (e.g. GILTI; BEAT, FDII).

4

State Partial Conformity with the TCJA

– Impact of the TCJA on Corporations:

• A federal tax cut of about 10%.
• A state tax increase of about 12%.
• COST/ EY study “The Impact of Federal Tax Reform on State

Corporate Income Taxes” (based on 2018 update and pre-federal tax reform (FTR) linkage to IRC).

– This outcome is inadvertent and arbitrary: If states simply conform to the TCJA, either automatically or by updating the conformity date, and do nothing more they will link to federal corporate base-broadening measures, but not to federal tax rate reduction.

5

Business Tax Provision

% Change in Federal Corporate Tax Base

State Conformity

One-time transition tax on unrepatriated foreign earnings + 9 % Partial conformity (but typically of 25% or less) Net interest expense limitation (30% of ATI) + 6.4% Mostly conformity Global intangible low-taxed income (GILTI) + 5.5 % (gross) Mixed conformity Modification of net operating loss deduction + 5.3% States have own provisions Base Erosion and Anti-Abuse Tax (BEAT) + 4.0% Non-conformity Amortization of research and experimental expenditures + 2.9% Conformity Repeal of domestic production activities deduction + 1.9% Partial conformity Foreign derived intangible income (FDII) deduction

• 1.7%

Mixed conformity (but §250 issue) Expensing provided under Section 168(k) bonus depreciation

• 1.8%

Limited conformity Global intangible low-taxed income (GILTI) deduction

• 2.6%

Mixed conformity (but §250 issue) 100% foreign DRD

• 5.9%

States have own provisions

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Top Increases and Decreases in Federal Corporate Tax Base with TCJA and Potential State Conformity

State Tax Budget Considerations

– Anticipated state tax revenue increases from the Wayfair decision, conformity with the TCJA, and a sustained economic recovery

• $8 billion to $33 billion estimated annual sales tax revenue increase

(cited in SCOTUS Wayfair decision)

• $6 to $8 billion estimated annual state corporate income tax revenue

increase from state conformity with the TCJA (COST/EY study)

– The federal limitation on the state and local tax deduction is a significant concern for many states, particularly those along both coasts. – Looming federal deficit/debt crisis may limit federal revenue sharing with the states in the long-term

• The CBO projects the federal debt will increase to $33 trillion in 2028,

a higher level than any point since just after WWII.

• 33% of all state and local revenue comes from federal funds.

– Some states have structural budget gaps arising from pension liabilities, infrastructure needs and rising health care costs

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Key International Tax Provisions Impacting the States

Global Intangible Low-Taxed Income (GILTI)

– GILTI is a new annual federal calculation intended to ensure a minimum tax is paid on worldwide income and is effective in 2018. – Three components are used in the federal GILTI calculation:

• IRC §951A: Includes all global income earned by the taxpayer’s

foreign subsidiaries. Makes assumption on how much is intangible based on a set rate of return on tangible assets.

• IRC §250(a)(1)(B)): Provides an offsetting deduction to lower the

effective tax rate.

• Foreign Tax Credits: Finally, a credit is provided for 80% of taxes

paid to foreign jurisdictions on the GILTI income, which ensures

• nly low-taxed foreign income is subject to federal taxation.

Generally, a taxpayer will not be subject to residual U.S. tax if the average foreign tax rate imposed on such income is at least 13.125%.

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Is the Impact of GILTI different for State Tax Purposes than for Federal Tax Purposes?

– Global: Yes, it includes all of the global income earned by the taxpayer’s foreign subsidiaries from conducting active trade or business – Limited to Intangible Income: No, it includes significant income from services, digital products, financial services, a sizable portion of tangible property sales, and intangibles. – Low-Taxed: No, the states do not conform to the (80%) foreign tax credit allowed for federal tax purposes to offset the GILTI

• income. In addition, many of the states may not conform to IRC

Section 250 that allows for a 50% deduction for GILTI income. – Offset by Corporate Tax Cuts: No, states do not conform to federal corporate tax cuts (Congress is raising $324 billion over 10 years from the international tax provisions to help pay for $654 billion in business tax cuts).

10

HI ME RI VT NH MA NY CT PA NJ DC DE WV NC SC GA FL IL OH IN MI WI KY TN AL MS AR LA TX OK MO KS IA MN ND SD NE NM AZ* CO UT WY MT WA OR ID NV CA VA MD

AK

Decoupled from GILTI by legislation or administrative action (in some states, subject to DRD limitations) Coupled or potentially coupled to GILTI** Have not addressed I.R.C. conformity and/or GILTI coupling specifically Potentially coupled to GILTI, but inclusion is constitutionally prohibited in separate reporting states*

Current Status of State Conformity to GILTI

* See Part III.D for discussion of the taxation of GILTI in separate company states. ** Generally, GILTI is not specifically referenced in state conformity statutes so there remains the possibility that some of these states will decouple from some or all of GILTI by administrative guidance (e.g., Kentucky, Connecticut)

• r future clarifying

legislation. Source: Council On State Taxation

Kraft precedent: Constitutional Limitations on the State Taxation of Foreign Commerce

• Separate Reporting States: See Kraft General Foods Inc. v. Iowa

Department of Revenue, 505 U.S. 71 (1992). A separate reporting state may not tax dividends from a controlled foreign corporation if it does not tax dividends from a controlled domestic corporation.

• Important to recognize that the governing principle was not discrimination against

dividends per se, but against foreign commerce. Thus, under the Kraft precedent, the state taxation of GILTI would be similarly prohibited in separate reporting states.

• Combined Reporting States: The fact pattern is different for taxing foreign

subsidiaries dividends (or GILTI) in combined reporting states because these states include the income and apportionment factors of domestic subsidiaries in the calculation of taxable income.

• Nonetheless, the taxation of GILTI in combined reporting states likely

violates Commerce Clause limitations unless foreign “factor representation” is allowed. Otherwise, the foreign income is discriminated against because its income-generating factors are not taken into account.

• See contra: E.I. du Pont de Nemours & Co. v. State Tax Assessor, 675 A.2d 82

(Maine 1996) and Appeal of Morton Thiokol, Inc., 864 P.2d 1175 (Kan. 1993).

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Factor Representation: GILTI

• If combined reporting states choose to tax GILTI, but concede it is

necessary to offer factor representation, what might factor relief look like?

• Basic principles to follow:
• Utilize the factors of all of the CFC’s and not just the first CFC in

a multi-tiered foreign chain.

• Include the gross sales of the CFCs in the denominator of the

sales factor, and not just the net GILTI amount.

• Adjust the gross sales as necessary to reflect only the portion
• f CFC gross sales that are related to GILTI.
• Don’t reduce the foreign gross sales to account for the

Section 250 deduction (because this is intended federally as a rate reduction and not a tax base adjustment).

• Combine the foreign gross sales (as adjusted) and other foreign

factors (as appropriate) with the domestic sales and other domestic factors and apply to the income of the waters’ edge combined reporting group (including GILTI).

13

Factor Representation: GILTI cont.

• Precedent for this factor representation approach can

be found in:

• The IRC model for computing allowable foreign tax credits relating

to GILTI.

• The “Detroit formula” used by some states and localities for factor

relief relating to the taxation of foreign dividends.

• The approach taken by the Multistate Tax Commission Model

Statute for Combined Reporting for factor representation relating to certain categories of foreign source income such as subpart F income or income from so-called 80/20 companies. In each instance of foreign income inclusion, the MTC model statute includes in the taxpayer’s apportionment calculation “the apportionment factors related to that income.”

• A similar approach may be required for factor

representation for the transition tax on repatriated earnings.

14

IRC §965(a) Mandatory One Time Deemed Repatriation (Transition Tax)

– IRC §965(a) provides for a one-time mandatory deemed repatriation of 30 years of accumulated foreign earnings.

• The IRC §965(a) provisions are effective in 2017.
• IRC §965(c) reduces the federal tax rate on repatriated earnings to

15.5% for earnings of cash and cash equivalents and 8% for all

• ther earnings.
• The transition tax is reported on a new federal form created specifically

for the one-time deemed repatriation, and is not reported as part of the regular federal taxable income.

• The transition tax can be paid in installments over eight years.

– About one-third of the states currently conform (in part) to the transition tax based primarily on prior treatment of foreign dividends or Subpart F income.

15

AK HI ME RI VT NH MA NY CT PA NJ DC DE WV NC SC GA FL IL OH IN MI WI KY TN AL MS AR LA TX OK MO KS IA MN ND SD NE NM AZ CO UT WY MT WA OR ID NV CA VA MD

Potential State Taxation of Accumulated Foreign Earnings

Source: COST/STRI/EY study

Assumes no impact Assumes partial or full impact California special treatment

This analysis assumes each state will update to the 2018 IRC consistent with the provisions the state conformed to prior to the enactment of the

• TCJA. This map is intended for general information purposes only and should not be relied upon for tax advice.

Transition Tax State Issues

17

• Will states adopt the 965 (c) tax rate reduction?
• Apportionment and factor representation issues.
• As the “deemed” dividends represent 30 years of earnings, what would

adequately provide factor representation?

• Over the 30 years encompassed in the mandatory “deemed” dividends

period, a U.S. Corporation’s footprint in any given state may have changed significantly, and the state’s method of apportionment (3FF, SSF) and tax rate may have changed significantly.

• Earnings and profits are netted at the federal consolidated group
• level. This presents unique issues in separate entity states and

states where the filing group differs from federal.

• Should the federal net earnings and profits be allocated among the group

members?

• Should taxpayers prepare separate E&P calculations based on the state

filer, which could result in state specific “deemed” dividends?

• If all mandatory repatriated income is excluded, will the state

disallow expenses associated with the income?

• Should states allow taxpayers 30 additional days to file 2017

returns or provide a penalty waiver?

Transition Tax State Issues

18

• California
• Worldwide/water’s edge
• APB 23 considerations
• Maintain – item disclosure on state tax implications
• Remove – deferred taxes on future dividends
• Actual cash dividends
• DRD – eliminated or 75%
• Previously tax income
• Factor representation issues
• Oregon
• Will treat transition tax income as subpart F—provides 15 or 20 percent

DRD

• Repealed tax haven provisions and adopted a credit for 2017 to avoid

double taxation on previously included income (S.B. 1529)

• On October 15, DOR released emergency rule that allows a taxpayer to

elect to subtract previously included income pursuant to the tax haven provisions for tax years 2014-16 as opposed to using the statutory credit

• See OAR 150-317-0652

Foreign Derived Intangible Income (FDII): IRC §250

– General Overview: Provides a 37.5% deduction for certain income earned in the U.S. attributed to foreign sales relating to U.S.-held intangibles.

• Results in a reduced effective tax rate on covered income of

13.125%, subject to a taxable income limitation (16.40625% after 2025).

– State Tax Issues:

• Deduction for FDII under IRC § 250 is likely a “special deduction,”

thus the impact (benefit) may be dependent on whether a state’s starting point for calculation of state taxable income is Form 1120 line 28 or line 30.

• The impact of FDII will be affected by a taxpayer’s state income

tax filing method.

• Selective decoupling – FDII, as enacted, is designed to work with

GILTI.

19

Key Domestic Tax Provisions Impacting the States

Interest Expense Limitation – IRC § 163(j)

• General Overview: Business interest expense cannot

exceed 30% of FTI exclusive of business interest income, business interest expense, depreciation, amortization.

• State Tax Issues:
• Unlike most states, TCJA coupled the interest expense limitation to

100% expensing for cost of capital.

• How is the limitation computed for state purposes when state and

federal filing methodologies differ?

• Conformity to consolidated return regulations
• External vs. internal debt (especially for sep. return jurisdictions).
• Will state allow indefinite carryforward of disallowed interest

expense?

• How will the federal limits interact with state related party interest

expense disallowance statutes?

• States that have decoupled to date from 163(j): Connecticut,

Georgia, Indiana, Mississippi, South Carolina, Tennessee (2020), Wisconsin.

21

100% Bonus Depreciation – IRC §168(k)

• General Overview: Current bonus depreciation

percentage under IRC §168(k) is increased from 50% to 100% for property acquired and placed in service after September 27, 2017, and before December 31, 2022. The 100% expensing is phased down by 20 percentage points per calendar year beginning in 2023.

• State Tax Issues:
• Will states conform?
• States that historically decoupled from bonus, will

likely decouple from the increase to 100%

• Straight coupling to federal vs. MACRS vs. different

approaches

• Tracking different methods in different states

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