To conform or not to conform, that is the question. Although much of Shakespeare’s interaction with taxation occurred outside the theater, his eternal words perfectly express the dilemma facing states after the passage of Pub. L. 115-97. In order to save time, money, and political capital, many states conform to the Internal Revenue Code (I.R.C.), meaning large portions of state revenue codes borrow their provisions from the federal tax code. The scope of change wrought by the 2017 tax act is forcing states to reconsider conformity provisions, dependent upon each state’s individual situation. The loss of the personal exemption may result in a large tax hike in one state, while the repeal of the domestic production deduction and the introduction of immediate expensing may be the main concern of another.
Conformity comes in three flavors: rolling, static, and selective. Rolling conformity states, such as Alabama, Michigan, and Illinois, adopt amendments to the I.R.C., such as the TCJA, immediately, without the need for conforming legislation by virtue of their statutory language. Static and selective conformity states however, such as Kentucky, California, and Hawaii, require legislation to adopt new federal amendments. Regardless of what category a state falls into, expect to see fireworks this spring and summer as legislatures across the country grapple with the economic, social, and political consequences of conformity.
States with rolling conformity are mulling its effects and the state government’s possible responses. Even rolling conformity states do not conform to all parts of the I.R.C., as they often exclude provisions that are inapplicable or are against the state’s interests. For example, states may not need statutes governing international taxation, but may want to determine their own tax brackets and rates. In these cases, states pass legislation decoupling from these specific I.R.C. provisions. For example, every state has decoupled from the federal rates and brackets.
The decisions facing the states, therefore, revolve around how particular provisions in the tax act affect the unique set of circumstances each state faces. Michigan, a rolling conformity state, has recently scrambled to protect its personal exemption, which the federal legislation eliminated. Economists have estimated the impact of the loss of the Michigan personal exemption may lead to a $1.4 billion tax increase, as reported by Alex Ebert in Bloomberg Tax’s Daily Tax Report: State. This prompted Michigan Gov. Rick Snyder (R) to propose retaining the personal exemption. The Michigan Senate responded by passing legislation decoupling from the personal exemption provisions of Pub. L. 115-97, which is now under consideration by Michigan’s House of Representatives. High-tax rolling conformity states, such as Illinois and Connecticut, will need to make equally difficult decisions in the months ahead.
Static Conformity: A Blast from the Past
Static and selective conformity states, on the other hand, choose the version or provisions to which they wish to conform. Static conformity states conform to a version of the I.R.C. existing on a particular date, while selective conformity states pick provision to which they wish to conform, and do not conform otherwise. For a majority of states, this simply means passing conforming legislation every year, with the opportunity to decouple should they dislike an amendment to the federal code. For some, however, static and selective conformity has created a revenue time capsule. Texas’ franchise tax provisions currently conform to the 2007 version of the I.R.C., and New Hampshire, until 2017, conformed to the I.R.C. version in force during the year 2000.
Static and selective states arguably have a more difficult decision to make. First, state legislatures must parse out each individual amendment and decide whether continued conformity, partial conformity, or complete decoupling would be good for the state’s economic health. Layered on top of the objective economic review is a more subjective political element that could become the deciding factor in some areas of the country.
As state legislation season heats up, tax practitioners can expect a wave of legislation enacted to address the tax act. What happens next is anyone’s guess, but rest assured that Bloomberg Tax will be there covering every angle as the drama unfolds. In addition, the Bloomberg Tax I.R.C. Conformity Tool can help practitioners stay up to date on the latest developments.
Continue the discussion on Bloomberg BNA's State Tax Group on LinkedIn: What provisions will you be keeping tabs on to track state conformity across the nation?
For more information on the impact of Pub. L. No. 115-97, examine Bloomberg Tax’s Tax Reform Roadmap, showing detailed comparisons between pre-reform law and impending changes, with pertinent cites attached.
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