Federal Tax Overhaul Would Force Major State Policy Decisions

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 Chris Marr

States will have big decisions to make around business taxes and deductions of companies’ capital investments—as well as potential tax revenue windfalls—if the GOP’s federal tax overhaul is enacted, attorneys predicted.

The tax plan that House Speaker Paul D. Ryan (R-Wis.) and others are advocating would be “the most transformational corporate tax reform since 1913, not just federal but also state,” said Karl Frieden, vice president and general counsel at the Council On State Taxation in Washington.

If the plan passes later this year, as Frieden predicts—particularly if it includes effective dates in 2017 or 2018—state legislatures could “call emergency sessions to consider what they do with it,” he told practitioners Jan. 20 at the American Bar Association’s Section of Taxation midyear meeting in Orlando, Fla.

Most of the federal plan won’t directly affect states. But they will have to consider a few key points, including the end of a federal bonus depreciation policy, said Jordan Goodman, co-chair of the state and local tax group at Horwood Marcus & Berk Chartered in Chicago, who spoke on the ABA panel along with Frieden.

The House tax plan would let businesses immediately deduct 100 percent of capital investments. States have typically followed federal policy on business investment deductions and depreciation, but Goodman said the 100 percent deduction might be hard for states to swallow, particularly if it has no cap.

State Revenue ‘Windfall.’

States also might find themselves deciding what to do with a large influx of tax revenue.

The proposed federal plan from House Republicans includes cuts to corporate and individual tax rates, along with eliminating many corporate and individual deductions to “broaden the base,” Frieden said.

“It should be a windfall for the states,” Goodman said. “The base is getting larger,” and the federal rate “doesn’t affect them.”

The plan includes a 20 percent corporate tax rate, a 25 percent tax rate for passthrough entities and a top individual tax rate of 33 percent followed by 25 percent and 12 percent brackets.

States could face pressure to return the extra tax revenue in the form of their own tax rate cuts. The House plan largely offsets the cost of corporate tax cuts by eliminating individual tax deductions, Goodman said.

These proposals include ending the federal deduction for state and local taxes, which Frieden said would amount to $1 trillion over 10 years.

Destination-Based Taxes: ‘Radical Change.’

The most “radical change” proposed in the House plan relates to the border-adjustability policy, which would eliminate corporate taxes on income from exports but not allow companies to deduct costs related to imports, Frieden said.

This policy shifts the focus of corporate income taxes from the place of origin—where products are made—to the destination—where products reach the end consumer, he said.

“The issue of origin-based versus destination-based income tax will be a big fight at the states,” Frieden said.

State policymakers already disagree about the fairest way to apportion income of multistate businesses for tax purposes, he said.

More than 20 states use a three-factor apportionment model that determines a company’s state-taxable income in terms of its property, payroll and sales within the state.

On the other hand, roughly half of states have switched to a single-factor formula that only considers sales in determining how to apportion income of multistate companies—essentially a destination-focused tax policy for those companies.

The three-factor model is endorsed by the Multistate Tax Commission, although in recent years, it has supported double-weighting the sales factor, as many of the states using a three-factor formula have done.

“We could be in for a really interesting year, a really interesting couple of years, if this passes,” Frieden said.

States would also have to decide whether and to what extent they would conform to the federal border-adjustability policy, in terms of how state tax authorities treat companies’ income from exports and costs of importing, Goodman said.

To contact the reporter on this story: Chris Marr in Orlando, Fla., at cMarr@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

Copyright © 2017 Tax Management Inc. All Rights Reserved.

Request Weekly State Tax Report