Spring 2018 issue of Horizons

Corporate taxpayers may want to be more diligent in identifying and securing state income tax credits that provide dollar-for- dollar offsets to the state income tax that results, despite the NOLs.

H.R. 1 shifts the United States from a “worldwide” system of taxation closer to a “territorial” system of taxation

International Taxation H.R. 1 shifts the United States from a

“worldwide” system of taxation closer to a “territorial” system of taxation, in alignment with tax regimes in most other developed countries. Under the new territorial system, deferred earnings are deemed repatriated at the end of calendar year 2017, making them immediately taxable at the federal government rates for Subpart F income. The state tax implications of these repatriated earnings will vary greatly among the states. For instance, the foreign source income exclusion for corporations reporting tax to Colorado is only allowable when the taxpayer claims a foreign tax credit on the federal return. This exclusion is further limited by an extracurricular calculation and could result in surprises for many taxpayers. However, the state allows all corporate taxpayers to reduce federal taxable income for the federal section 78 gross up. Other states like California, Montana and North Dakota have either required or allowed taxpayers to file state returns on a worldwide basis. Taxpayers in these states will need to consider adjustments to deemed repatriated income reported for federal purposes to avoid duplicate taxation. Individual Income Taxation Many of the states that have an individual income tax, including California, Illinois, Kansas and Missouri, have adopted the IRC’s definition of adjusted gross income (AGI) as the starting point for calculating state income tax. In AGI states, adjusted federal gross income carries to the state tax return before any standard or itemized deductions. Six states, including Colorado, start their calculation of state income tax with “federal taxable income.”

Interest Deductibility H.R. 1 now limits the deduction of business interest to 30% of modified income, with exceptions for taxpayers with average annual gross receipts less than $25 million over the prior three years, and certain real property and farming businesses. These changes will increase state income taxes for affected taxpayers. Corporate Taxation Of the states with a corporate income tax, California, Tennessee and at least 20 other states have adopted federal taxable income before net operating losses (NOLs) and special deductions as the starting point to calculate income tax. Colorado, Illinois, Kansas and Missouri plus 14 other states begin their calculations with federal taxable income after NOLs and special deductions. Treatment of Net Operating Losses Prior federal law allowed a NOL to be carried back two years and forward for twenty years. Federal tax reform eliminates NOL carrybacks, while providing for indefinite carryforwards. New federal law also limits the application of NOLs generated after December 31, 2017, to 80% of federal taxable income. While few states fully conform to the federal NOL provisions, some states adopt the IRC section addressing NOLs. Thus, the opportunity to use a state NOL to offset all state taxable income may be similarly limited, resulting in state income tax on 20% of state taxable income.

The New Federal Tax Law has a Big Impact...Even on Each State

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