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States may see revenue from the deemed repatriation of income from foreign subsidiaries of U.S. corporations in an indirect way—by taxing individuals.
“Some of the states had already given up that they would have any income” from deemed repatriation, Michael Fatale, deputy general counsel at the Massachusetts Department of Revenue, said March 9 during a Federal Bar Association tax law conference in Washington.
“And then there was a thought that, ‘Wait a minute, maybe we gave up too soon,’” he added, “because there could be individuals who are going to receive some of that income.”
The 2017 federal tax act ( Pub. L. No. 115-97) uses Internal Revenue Code Subpart F to impose a one-time toll charge on the undistributed, previously untaxed post foreign earnings of certain foreign subsidiaries of U.S. companies.
For the most part, states don’t tax Subpart F income because the states face constitutional restraints meant to prevent discrimination against foreign income. Besides, international trade is a realm left for the federal government to regulate and tax.
Many states assumed they wouldn’t benefit from repatriated income, Fatale said. But after several weeks of studying the new federal tax law, a significant number of states determined that some of that repatriated income could end up as a divided distribution to individual shareholders, subject to individual income taxes, he said.
State taxation of foreign-business income may become more complicated due to various federal deductions, including one concerning intangible assets, and by a new federal provision regarding global intangible low-taxed income (GILTI), which adds to a morass that includes constitutional limits on states.
GILTI is a new category of income, similar to Subpart F of the IRC in that it’s deemed repatriation in the year earned.
GILTI is the income of a controlled foreign corporation, reduced for certain adjustments such as U.S. effectively connected income or other Subpart F income that exceeds 10 percent of the qualified business asset investment, related to Section 167 of the IRC.
That’s the gist, though the intricacies of the law are complicated, particularly for states that use federal taxable income as the starting point for taxable income, as opposed to adjusted gross income, Steve Wlodychak, a principal with Ernst & Young LLP’s Indirect Tax Practice, told Bloomberg Tax.
These states could include both the gross income inclusion required by those provisions and the corresponding deduction, meaning they would have the same inclusion amount and deduction as provided under the new federal law, he said.
States will need to take steps to account for the new federal provision regarding repatriated income, but predicting how they will react or what form legislation will take is difficult, Alysse McLoughlin, partner and tax attorney at McDermott Will & Emery, said at the ABA conference.
And when it comes to taxing foreign-income dividend distributions to individuals, most states provide a deduction or exclusion for foreign dividends, McLoughlin said.
A recent report released by the Council On State Taxation and Ernst & Young LLP said seven states tax 30 percent or more of a taxpayer’s foreign source dividends from wholly owned subsidiaries. These states, plus several imposing tax on a smaller share of foreign dividends, are assumed to be impacted by federal changes regarding deductions for domestic and foreign dividends received under IRC Sections 243 and 245, the report said.
States are already seeing an increase in revenue as a result of the new federal tax law, though not because of deemed repatriation.
The federal law led to the strongest quarterly growth in state revenue in years as taxpayers looked for ways to prepay their 2018 tax bills before tax breaks expired, according to a March 12 report from the Nelson A. Rockefeller Institute of Government.
The report said personal income tax revenue in the fourth quarter of 2017 rose by 16.6 percent, and sales tax revenue increased by 6.9 percent, according to preliminary data. Overall state tax revenue grew by 12.2 percent compared to the fourth quarter of 2016, according to the report.
“We’re beginning to see the early effects of President Trump’s Tax Cuts and Jobs Act in the tax revenue data, especially as high-income taxpayers take advantage of the state and local tax deduction before it’s capped at $10,000,” Jim Malatras, president of the Rockefeller Institute, said in a statement. “And we expect more fluctuations as states figure out how to mitigate the law’s impact.”
The report said the strong growth may only be temporary because it’s linked at least partly to the federal tax law.
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Text of the Nelson A. Rockefeller Institute of Government report is at http://src.bna.com/wZX.
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