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Nov. 3 —Either Hillary Clinton or Donald Trump could have a big impact on state and local taxes by affecting federal tax code changes. But their attitudes toward the independence of the Internal Revenue Service may have a greater impact.
“Under Clinton, we can expect the IRS to have greater room, which could mean traps for the unwary,” Brian Kirkell, leader of McGladrey LLP’s Washington National State and Local Tax practice, told Bloomberg BNA. “Under Trump, I think we could expect the IRS to be on a tight leash.”
The IRS has “a lot of leeway in enforcement and informal guidance,” and this is where the IRS could make significant changes that would require states to possibly react, he said.
Given the anticipated gridlock in Congress, chances for sweeping new tax laws are slim, so IRS guidance, enforcement actions and general counsel memos may be where states will see the greatest changes under the next president.
“While it is looking like the Democrats may take the Senate, they won't take the House,” Kirkell said. “An all-Democratic Congress and Clinton presidency, something might change. Trump as president with a Republican Congress, then you will see something happen.”
Proposals from Trump would appear to impact tax administration by states more so than those offered by Clinton.
Trump proposes elimination of the head-of-household designation for federal personal income taxes, a designation that many states use, according to Norton Francis, a senior research associate in the Urban-Brookings Tax Policy Center at the Urban Institute.
For those states, the change could lead to an administrative headache if they decide to create their own head-of-household designation, Francis, who works with the institute's state and local finance initiative, told Bloomberg BNA. Each state will have to make that decision.
Kirkell said the head-of-household change probably wouldn't have much of an impact on states.
When it comes to Democratic candidate Clinton's tax proposals, “the tax rate side is where most of her changes would be made,” Kirkell said. They would impact the income of the state, but not the administration.
The most important aspect of Clinton's tax proposal is likely her desire to impose a surtax of 4 percent to 5 percent on very high incomes, said Joseph R. Crosby, a principal with MultiState Associates Inc.
Such a proposal could present challenges for states that impose high marginal rates, bringing the top combined rate in a state such as California to almost 58 percent, he told Bloomberg BNA.
“That could increase the interest on the part of high earners to consider relocation to other states,” Crosby said.
Trump's plan, as it stands, would generally eliminate tax deductions and significantly reduce rates.
Given the estimates on the cost of his plans—almost $1 trillion in annual tax cuts—there would undoubtedly be significant changes through the legislative process, Crosby said.
“But, taken on its face, Trump's proposals would likely result in significant additional state tax revenue given the much broader base,” he said. “However, the limits on itemized deductions would increase the after-tax cost of state personal income taxes.”
Meanwhile, several IRS actions during the last year will shape states' fiscal framework, and the Nov. 8 elections may have limited influence over the flow-through impact from some.
For example, some states appear to be scrambling to conform to a new partnership audit approach starting in 2018. Enacted as part of the Bipartisan Budget Act of 2015, and effective for taxable years after Dec. 31, 2017, the rules provide that IRS partnership audits will be conducted and adjustments collected at the entity level.
The IRS plans to propose implementing regulations by the end of the year. The agency in August released temporary regulations (T.D. 9780) on the option to elect in early. And legislation proposing technical changes to the statutory partnership audit regime could also surface before year's end, or in early 2017, potentially impacting the IRS rules or state conformity statutes.
“Many states still have not conformed,” Kirkell said.
Nonetheless, the incoming president may have little influence on the new audit treatment of partnerships.
“This is such a complex, niche area that neither the Trump nor Hillary plan really contemplates getting so granular as to deal with something like that,” Bruce P. Ely, co-chair of the state and local tax practice team at Bradley Arant Boult Cummings LLP, told Bloomberg BNA. “I don't think that kind of technical corrections bill will rise to the level of a major issue in their tax plans.”
Ely is also co-chair of an American Bar Association Section of Taxation state and local tax committee task force that is addressing the state implications from the new federal law. The task force has forwarded recommendations to a Multistate Tax Commission work group, which is in the early stages of assessing the new federal partnership audit regime and considering model language.
Most states will want to adjust their rules to match the federal government's so they can piggyback on the federal government's collection efforts, Kirkell said. States want the federal government to do as much of the administrative work as possible.
So far, Arizona is the only state that has attempted to legislatively conform to the rules, with plans to rework some provisions. Other states may be itching to rapidly respond to the rules, but Ely cautioned officials to slow down and wait for IRS guidance and congressional corrections.
“I haven't even seen draft legislation from congressional staffers yet on the partnership audit rules,” he said, adding that the new audit approach hasn't generated the kind of controversy accompanying other recent federal changes, such as the Treasury Department's final and temporary debt-equity regulations. “We don't see any groundswell of support for repealing them. It's just a matter of tweaking them, and I hope we can all agree on what those tweaks will be.”
On Oct. 13, the Treasury Department announced final and temporary regulations (T.D. 9790) under tax code Section 385 to rein in earnings stripping through excessive indebtedness between related entities—both domestic and foreign. The Treasury's effort to curb the manipulation of intercompany debt transactions has raised sweeping questions about how it may shape state policies and procedures.
The federal focus on intercompany interests and transactions is of particular consequence to states that require combined reporting of all of a company's entities, Kirkell said.
The rules were expected to target only cross-border debt instruments, but intercompany debt issued in wholly domestic transactions falls within the regulatory scope. However, federal consolidated groups fall outside the regulations—and practitioners have told Bloomberg BNA that the rules don't solve the riddle of whether and how states may conform to or apply the federal regime.
“States don't like intercompany interests,” Kirkell said.
Moreover, states are increasingly interested in doing their own transfer pricing studies as a result of the IRS' recent work on intercompany interests, Kirkell said.
“That's the type of thing we might expect,” he said.
Neither candidate has articulated a clear position on Treasury's debt-equity rules, making it unlikely that the presidential election will have much influence on the regulations.
Julian A. Fortuna, a tax partner with Taylor English Duma LLP, told Bloomberg BNA that Clinton's federal tax overhaul proposal favors further earnings-stripping legislation. However, her proposal to tighten down on earnings stripping isn't specific, “so I don't know whether she is in essence saying that she supports the 385 regs or whether she is proposing some other way to deal with earnings stripping.”
Likewise, Trump has been silent on the issue.
“He has come out with some detailed proposals on the repatriation of foreign profits and some other issues surrounding companies doing business abroad,” Fortuna said. “But I haven't seen anything that he's come out with that talks about 385.”
When it comes to Trump's plan to eliminate estate taxes, Norton said the impact would vary a lot depending on whether a state has an estate tax, in which case it may decouple from federal tax rules, in turn, causing a new administrative duty for that state. Clinton's plan reduces the threshold for estate taxes, and many states would follow that, he said.
The damage to states in this area was already done with the cuts in 2001 and 2003, Norton said.
State death taxes aren't typically tied to the federal regime, though that may not always be the case, Kirkell said.
Ultimately, the tax plans offered by the presidential candidates—including former New Mexico governor and Libertarian Party candidate Gary Johnson and the Green Party candidate, physician Jill Stein—aren't chock full of details, tax lawyers and researchers told Bloomberg BNA.
And this isn't a surprise.
“This is always the case,” Kirkell said. “Basically, they always say they want to lower taxes for the majority of voters.”
Clinton and Trump have been the least precise in their details in the area of corporate taxes, Kirkell said.
Clinton has said she supports eliminating the reinsurance deduction for foreign entities, and this may have a significant state tax impact in states with separate returns, not those with combined reporting, Kirkell said.
“They don't want to make any kind of commitment as far as corporate taxes are concerned because they are the donors,” he said.
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Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.
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