Multinationals Focus More on State Taxes as Result of Federal Law

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 and Che Odom

Multinational businesses are increasingly concerned about U.S. state and local taxes as a result of recent changes in federal tax law.

States, however, may be waiting to see what impact federal changes will have on revenue before addressing conformity with complicated foreign-income provisions.

“The risk of increases in both the state tax burden and the costs of compliance are driving a lot of the state tax policy conversations right now,” Diann Smith, tax counsel in the Washington, D.C., office of McDermott Will & Emery, told Bloomberg Tax.

The 2017 federal tax act ( Pub. L. No. 115-97) made sweeping changes, including shifting the U.S. tax system from a worldwide to a territorial tax regime in which all income is subject to taxation no matter where it’s earned. This presents special challenges for states which, unlike the federal government, face constitutional restraints when it comes to taxing foreign income.

States, examining the impact of the federal law on revenue, are debating how they should respond, while business taxpayers grow more concerned over the challenges they may face complying with 50 reporting systems in 50 states, plus the District of Columbia.

“State tax has definitely been elevated in importance as a result of federal tax reform,” Smith said, adding that states will be grappling with the new federal law for years to come.

State Tax Questions

Nicole Crighton, a principal in KPMG LLP’s state and local practice, said April 25 at an annual tax conference in New York that “increasingly, international tax people are starting to pick up on state tax questions.”

However, state revenue officials may not share the same level of interest, Ann Holley, a partner in the state and local tax group of KPMG’s Washington National Tax practice, said at the conference sponsored by KPMG and New York University.

“The reality is that state corporate income tax usually makes up only 6 percent or 7 percent of state budgets,” she said, “so it’s not as huge a deal from the state revenue perspective as you might think.”

States receive far more revenue from individual income taxes and sales and use taxes than corporate income taxes.

Still, state revenue officials are interested in the various foreign-income provisions, Nikki Dobay, senior tax counsel at the Council On State Taxation, told Bloomberg Tax.

“For corporate taxpayers, they are required to figure out federal tax reform and how that will work for all the states they operate in,” she said. “For the state revenue officials, however, they have a bit more tunnel vision because they are just dealing with their individual state. So, I think they are very interested but come at it from a much different perspective.”

States Looking for Money

State officials—certainly auditors—"have always had an interest in collecting the greatest amount of tax possible regardless of whether they’ve reached a fair or correct result,” and the recent federal tax law changes don’t change that, Jeremy Abrams, counsel in Reed Smith LLP’s state tax group, told Bloomberg Tax.

“We are already seeing state legislatures struggle” with many of the federal tax law’s provisions, “both international and domestic,” Abrams said. “The less thoughtful, more short-sighted their solutions are, the more risks and opportunities there will be for taxpayers.”

So far this year, state lawmakers have been focused on individual-income provisions of the federal tax law, with a relative handful of state legislatures addressing business-income provisions. A fewer number of states, Georgia, Hawaii, Illinois, Minnesota, New York, Utah, and Wisconsin, have either considered or enacted legislation that addresses federal foreign-income provisions.

In general, the initial approach has been for states to adhere to federal provisions that increase revenue and decouple from those that decrease revenue, Crighton said.

Foreign Income Provisions

Another complicating factor, state tax regimes have been territorial in nature because of the need to apportion income to states, so that they are taxing earnings appropriately. This “makes the policy implications of federal tax reform and the mechanics of the law even more difficult” at the state level, Holley said.

To be consistent, any inclusion of the new foreign income, the repatriation inclusion and global intangible low-taxed income, requires that the factors generating this income be included in the apportionment formula, Smith said.

“States will need to craft rules for how the factors are to be calculated,” she said. “It should not be enough to merely include the income in the receipts factor because the income is a net basis while the rest of the receipts are usually on a gross basis.”

Inconsistencies in Instructions

Another source of headaches will be inconsistencies arising out of state tax-return instructions, which “across the board” don’t yet reflect new federal guidance, Crighton said.

State instructions refer to federal taxable income as reported on Line 28 or Line 30 of the federal return but “mandatory repatriation won’t be there” because it appears on a separate Section 965 Transition Tax Statement and is included in the tax computation on Page 3 of Form 1120, she said.

That split between what the new U.S. law says and what the state instructions say will make the compliance mechanics “really challenging,” she said.

To contact the reporter on this story: John Herzfeld in New York at jherzfeld@bloomberglaw.com and Che Odom in Washington at codom@bloombergtax.com

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

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