Big Impact on States Seen From Federal Tax Reform

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

By John Herzfeld

Any significant tax reform at the federal level would have a big impact on state taxes, a specialist in state and local taxes said March 10.

A “difficult process” would ensue for states if Congress adopts something like the House Republican tax reform blueprint before a “new equilibrium” emerges, said Harley Duncan, managing director and state and local tax leader in KPMG LLP’s Washington national tax practice.

“It won’t be a smooth, linear transition, and the complexity will increase exponentially over time before we reach equilibrium,” Duncan said at an annual New York University-KPMG tax program in New York.

The broadest impact of federal reform on state taxes would spring from the fact that almost every state starts the computation of corporate taxable income with the amount from the federal return, even though states typically vary from federal tax policy in many areas, Duncan said.

About half the states automatically adopt federal changes in “moving” or “rolling” conformity schemes, unless they enact specific modifications decoupling from federal tax provisions, he said. Others have “fixed date” or “static” conformity, which matches the federal code as of a specific date.

In either scheme, he said, states will have to make a choice whether to accept any federal changes or decouple from them.

Timing Would Be Complicated

About 30 states, facing the need to balance their budgets, have decoupled from federal bonus depreciation rules, for instance, Duncan said.

In those states, conformity with immediate expensing of certain assets, as envisioned in the House blueprint and President Donald Trump’s campaign proposals, would have a comparatively greater impact, he said. But to the extent the federal change would affect computation of federal taxable income, an effect would still flow through to all states.

The timing and effective dates of any federal tax changes will be important, especially when many state legislatures will convene in early 2018 and adjourn by the spring, Duncan said.

“Timing is everything, and it will be messy,” he said. “The closer to the end of the year Congress acts, the more problems there will be.”

Depending on the effective dates, some states will have to convene a special session or put off addressing the federal changes until the following year, Duncan said.

State Beat Goes On

In addition, federal tax reform won’t stop the progress of state tax changes in 2017, as many states face budget shortfalls, so “be prepared for the usual plethora of state tax law changes,” Duncan warned.

Budget pressures would create a good argument for delay in adopting federal changes that would have the effect of reducing state revenues, but a competing influence will be the trend of state Republican leaders opting to drive down income tax rates, Duncan said. Republicans control a majority of state legislatures, he noted.

Some approaches in the House blueprint aren’t much different from state tax apportionment methods that look to where goods and services are produced and consumed, so state expertise in that area might prove valuable, Duncan suggested.

State experience “will come into play” as Congress considers proposals for destination-based cash flow tax and border adjustment, he said, adding: “States have already moved from taxing production to taxing consumption.”

To contact the reporter on this story: John Herzfeld in New York at jherzfeld@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

For More Information

Background materials from the NYU-KPMG program, including Duncan's presentation, are at http://src.bna.com/mVo.

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