By Steven Roll, Melissa Fernley, and Kathleen Caggiano
Steven Roll is an assistant managing editor with Bloomberg BNA. Melissa Fernley and Kathleen Caggiano are state tax law editors with Bloomberg BNA.
The American Taxpayer Relief Act of 2012 (ATRA), which President Obama signed into law Jan. 2 leaves intact most of the business tax breaks such as bonus depreciation that first took effect under President Bush. Tax incentives for alternative energy producers were extended. Large estates remain protected by a $5 million exemption.
For the most part, ATRA keeps things at the status quo for most states' tax codes, said Michael Mazerov, a senior fellow with the Center on Budget and Policy Priorities in Washington, D.C. Many aspects of ATRA, such as federal tax rates will not be reflected in state tax codes. The more significant provisions for states are those affecting the federal tax base, which is used as a starting point for computing income tax in most jurisdictions. But even here, the impact is likely to be minimal, he said. The legislation extends bonus depreciation, but Mazerov noted that the vast majority of states have already decoupled from this provision. For the handful of states that do allow bonus depreciation, the extension into 2013 will mean they will forgo a small revenue gain, he said. Renewable energy credits were also extended under ATRA, including the production tax credit for qualified wind energy facilities. States will likely see additional income and sales tax revenue from the renewable energy industry.
What is significant from the standpoint of the states is what ATRA did not do. “It could have brought back the state death tax credit, but that didn't happen,” said Mazerov.
Of greater importance to the states, he said, is likely to be the tax reform proposals that Congress might consider later in the year, such as eliminating the federal deduction for state taxes. But the extent to which any changes in federal law will be reflected in state tax codes depends on the approach each jurisdiction takes to conforming to the Internal Revenue Code. Twenty four states adopt the current version of the Internal Revenue Code. Each of these jurisdictions automatically conforms their tax codes to federal changes. The remaining states conform to the Internal Revenue Code as of a specific day.
One interesting question is whether the states may want to forego the uncertainties created by tying their business tax regimes so closely to the federal Internal Revenue Code, said Steven N.J. Wlodychak, a principal with Ernst & Young in Washington, D.C. “It will be very interesting to see whether the states seek greater control and certainty in their own tax regimes by decoupling even more from federal tax law changes, perhaps even throwing out the income tax laws in their entirety,” he added.
Even without federal tax reform, the outcome of the 2012 elections is likely to trigger significant changes to state tax codes. One of most important results of the elections is that in many states the same party controls both the legislature and the governor's office, said Wlodychak. “In California, for example, for the first time since 1933 one party, the Democrats, has a super-majority control in both the Senate and the House and also controls the Governor's office,” he said. “The legislature and governor now have the power to completely reform California's tax laws--something unheard of even just last year when Governor Brown was unable to obtain the vote of the legislature to increase taxes and appealed to the people through referendum--Proposition 30, which temporarily increased sales and personal income tax rates,” he noted.
“The same is the case in many states in the Midwest, although in these cases, it's the Republicans that have the super majority control,” Wlodychak said. “This solidification of political power in one party may mean that the respective states will take direct action to reform their tax laws in ways we can't yet determine.”
From a state fiscal standpoint, one of the most significant aspects of ATRA was its elimination of the federal credit for state estate taxes.
At the time of the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA), every state had a “pick-up” estate tax which was based on the federal estate tax credit for state estate taxes. Most states imposed an estate tax exactly equal to the credit. About a dozen states imposed their own estate tax, but made sure that in the event their estate tax calculations did not result in an amount equal to or greater than the credit amount, the total tax would be raised to equal that amount.
With the passage of the 2001 EGTRRA, Congress phased out the federal credit for state estate taxes, replacing the credit with a deduction. As a result, by 2005 none of the states imposing pick-up estate taxes received any revenue. “Until 2001 the estate tax was a great gravy train for all 50 states. Now they have to blaze their own trails,” said Alan S. Gassman, a partner at Gassman Law Associates, P.A. “EGTRRA's impact was severe on states that did not enact state estate taxes, or states that couldn't due to restrictions such as the state constitution in Florida,” Gassman added.
Even states which retained their individual estate tax regimes lost significant revenue, as independent state regimes still took advantage of the federal credit with a residual pick-up tax. As Walter Hellerstein, Professor of Taxation at University of Georgia Law School, stated in April before the Senate Committee on Finance, by 2005 the states were “mere shadows of their former selves, because their residual pickup taxes had disappeared and they were left with only their relatively modest 'independent' inheritance or estate taxes.”
While Congress temporarily reinstated the estate tax from 2010 to 2012, it did not reinstate the state estate tax credit. As a result, few were hopeful for its return in 2013, and Hellerstein predicted it was “the final chapter in federal-state tax cooperation in the death tax field.” Ever hopeful, some states, like New Mexico, chose to risk including anticipated tax credit revenue in their budgets, the Tax Policy Center reported.
The American Taxpayer Relief Act of 2012 (ATRA) repealed the state estate tax credit for good, leading some states scrambling to reassess their systems. At least two states have already acknowledged the need to scrap their pick-up tax regimes and develop a new estate tax approach. The California Legislative Analyst's Office recently acknowledged that the state would not receive revenue from estate taxes without the enactment of state legislation. Similarly, the Wisconsin Department of Revenue announced on its website that “the credit for state death taxes paid, which would have been the basis for Wisconsin's estate tax, has been eliminated.”
As state legislatures contemplate the future of their estate tax systems, potential residents will take the changes to the estate tax into consideration as well. States should “consider the potential negative impact such taxes have had on their citizens' wallets and the state's populations--estate taxes could be driving citizens out while also discouraging people from moving to the state,” Gassman said. “We have already seen kids say 'no way you are moving back up here Dad, we can give you a private nurse for the cost of inheritance tax if you live up here with us,'” he said. It is, as Gassman stated, “a sad testament to what people will do to avoid taxes,” but it is also the new reality of a system without a state estate tax credit.
ATRA extends for one additional year the current I.R.C. § 168(k) 50 percent bonus depreciation provision that applied to qualified property acquired in 2008 through 2012. As a result, instead of sunsetting in 2013, bonus 50 percent depreciation will apply to property acquired and placed in service before Jan. 1, 2014. For certain aircraft and longer production period property, the “placed in service” deadline is extended to Jan. 1, 2015.
The amendment marks the fifth time in five years that Congress has allowed accelerated depreciation of capital assets in an effort to stimulate investment. The Economic Stimulus Act of 2008 (P.L. 110-185), enacted Feb. 13, 2008, allowed an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified property, for both regular tax and alternative minimum tax purposes for property placed in service during 2008. The “placed in service” deadline was extended to 2009 for most types of property under the American Recovery and Reinvestment Act of 2009 (ARRA) (P.L. 111-5), enacted Feb. 17, 2009. The deadline was further extended to 2010 under the Small Business Jobs Act of 2010 (P.L. 111-240, Title II), enacted Sept. 27, 2010, and to 2012 under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Pub. L. No. 111-312), enacted Dec. 17, 2010.
ATRA also extends the increased expensing limitations and treatment of certain real property as I.R.C. § 179 property. Like bonus depreciation, the so-called “enhanced expensing” provision was first enacted in 2008 and has been extended through successive legislative measures over the past five years. Under ATRA for taxable years beginning in 2012, after statutory amendments and IRS inflation adjustments, small businesses may elect to expense up to $139,000 of capital investment. As in previous years, this limit is reduced dollar-for-dollar, but not below zero, for each dollar of first-year expensing property placed in service in the tax year that exceeds a threshold amount. ATRA sets this threshold amount at $560,000. Prior to ATRA the threshold amount was $200,000.
Neither extension is likely to have a significant impact on the states. Many states elected against adopting either tax break. Currently, 31 states have decoupled from bonus depreciation. In these states, taxpayers must add back to federal adjusted gross income all or a portion of the federal deduction before computing state income tax. “If history is any guide, at least two-thirds of the states that impose corporate income taxes will decouple from this new round of 50 percent federal bonus depreciation provisions for 2013 adopted as part of the fiscal cliff legislation,” said Jamie Yesnowitz, a principal with Grant Thornton LLP in Washington, D.C. A similar modification is required by 18 states for taxpayers who utilize the federal enhanced expensing provision.
More likely to bear the brunt of the continuation of these federal tax breaks are tax practitioners who must grapple with disconnect between the federal and state tax codes. Further complicating matters is the disparate policies among the states. Some states allow neither bonus depreciation nor enhanced expensing, while others may allow one tax break but not the other, explained Kelly T. Bugg a manager with the accounting firm Biegel & Waller, LLP in Columbia, Maryland. Practitioners will likely need to research which states conform and do not conform with the ATRA extending provisions, conforming and nonconforming states could differ from prior years, she said.
“The lack of uniformity among the states forces taxpayers to keep multiple sets of records,” said Yesnowitz. “Depreciation needs to be tracked for book purposes, for federal tax purposes, for states that completely decouple from the federal bonus depreciation provisions, and for states that provide a partial benefit for federal bonus depreciation,” he said. “The issues become even more challenging in decoupling states when a taxpayer sells property subject to federal bonus depreciation during the useful life of the property,” Yesnowitz added.
Differences between the federal and state adoption of “enhanced expensing” under I.R.C. § 179 also continues to vex practitioners. Small businesses frequently elect enhanced expensing at the federal level and “ the poor tax preparer needs to track it for say Maryland or Virginia,” said Joe Flack, a partner with Biegel & Waller. The adjustments, Flack said, can slip through the cracks. If a taxpayer changes accountants, the state adjustments taken over five to seven years can disappear if the new accountant doesn't ask for the workpapers,” Flack added.
While the trend has been for states to decouple from bonus depreciation, at least one jurisdiction is using the tax break as a way to encourage businesses to hire more employees within its borders. Ohio recently enacted legislation (H.B. 365) amending its personal income tax to allow owners of pass-through entities that increase income tax withholding by at least 10 percent in the preceding tax year to greater deductions for bonus depreciation and enhanced expensing at the state level. “Clearly, these new Ohio provisions are being implemented to give business owners of pass-through entities an incentive to increase the business footprint in Ohio--by hiring more employees subject to Ohio income tax withholding, said Yesnowitz. “For states that plan on partially or fully decoupling from the federal bonus depreciation provisions for personal or corporate income tax purposes, it may be desirable for them to consider whether preferential state-specific bonus depreciation for in-state job creators could be adopted as a means to encourage economic development,” he said. “Of course,” Yesnowitz added, “such a plan, if adopted in a number of states, could make determining the proper amount of depreciation to be taken on a state-by-state basis that much more of a challenge.”
A more positive development for the states is ATRA's extension of federal energy credits, including the production tax credit under I.R.C. § 45. The credit is extended for qualified wind energy facilities from Jan. 1, 2013 to Jan. 1, 2014. The states are likely to see additional income and sales tax revenue from the renewable energy industry, said Karl Gawell, Executive Director of the Geothermal Energy Association. Also, “the states will likely see more jobs created in the geothermal industry sector,” Gawell said. In addition, “[w]ith the extension now in place, . . . the [wind] industry can proceed with the development process of pursuing power purchase agreements, raising capital, placing orders for turbines, activating the supply chain, and construction, all of which create and maintain jobs” a spokesman for the American Wind Energy Association (AWEA) told BNA.
While many states offer their own tax credits for the production of renewable energy, these incentives are not sufficient, by themselves, to sustain growth, said Gawell. Despite the fact “[s]tates have always served as leaders in renewable energy policy, . . . [a] national policy is needed to maintain U.S. manufacturing working in tandem with policy leadership from the states,” the AWEA spokesman said.
But ATRA did not resolve the uncertainty surrounding the federal tax production credit. Because the provision was extended only for one year, it makes it difficult for the renewable energy industry to engage in long-term investments and planning that would likely benefit the states.
The chart below shows each state's approach to conforming to the Internal Revenue Code, treatment of bonus depreciation and enhanced expensing, and estate tax regime.
State Conformity to Federal Tax Breaks
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