Expect Confused Responses From States to Federal Tax Changes

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By Che Odom

Companies can expect some confusion among states as they attempt to respond to tax proposals coming out of Washington.

That’s according to a survey of 330 tax professionals by Ernst & Young LLP.

“Once federal tax reform is enacted, be ready for the state tax rebound,” Kate Barton, vice chair of the firm’s Americas tax services, said April 26 during an EY conference in New York. “They will at least need to patch and adjust according to the effect on their coffers.”

Survey respondents forecast state-by-state confusion following potential federal tax reform, with 58 percent expecting to see a patchwork of changes to adjust. Another 27 percent believe states will leave their policies as status quo until new federal policies have started affecting them, and 15 percent expect states to follow with wholesale tax reform.

President Donald Trump’s tax reform plan, which was unveiled at the same time as the EY conference April 26, would scrap the popular deduction for state and local taxes. During a press briefing, Treasury Secretary Steven Mnuchin and National Economic Director Gary Cohn confirmed that the administration’s tax proposal would jettison all itemized deductions for individual taxpayers, with the exception of mortgage interest and charitable contributions.

In unveiling the opening bid for what officials called the “biggest tax cut” in U.S. history, the administration’s list of goals include reducing the federal income-tax rate to 15 percent for corporations, small businesses and partnerships of all sizes. It also imposes a one-time tax on about $2.6 trillion in earnings that U.S. companies have placed overseas. The plan would end the taxation of corporations’ offshore income by moving to a territorial system, in which most foreign profits would be exempt from U.S. taxes. The U.S. currently taxes business income no matter where it’s earned.

Conformity ‘Key’

Keith Anderson, national tax partner in the Dallas office of Ernst & Young, said during the EY event that how states respond to tax changes out of Washington will depend greatly on how the state conforms to the federal tax code.

States differ on federal conformity. Some have fixed or selective conformity, which require some action to respond to any federal changes, while others have “rolling” conformity, in which alignment with federal code occurs automatically.

Decouple or Not

Generally speaking, if rates are reduced but the base isn’t broadened, states, including those with rolling conformity, may decide to decouple from the federal code, he said.

All of this could take time, as some states, such as Texas and New Hampshire, have demonstrated they can take years to respond to federal changes, he said.

“This conformity issue is really key,” Anderson said. “Some will practice conformity, others will not.”

This will mean companies must assess what would be the best tax strategy to take to make the most of state codes, including income apportionment formulas, he said.

A large number of respondents, 38 percent, to the EY survey said ideally they would like Congress and the White House to work toward a flat income tax rate without credits or deductions. Many also said they favor a value-added tax and border adjustments.

States Behind?

Deane Eastwood, principal in Ernst & Young’s indirect tax practice, said many state legislatures “have not spent a lot of time thinking about what they are going to do” when it comes to reacting to federal changes.

“Most of the states I work in are still looking at conformity, market-based sourcing,” issues that “we have been looking at for 10, 15 years,” he said.

To contact the reporter on this story: Che Odom in New York at codom@bna.com

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

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