a whole new world: state tax post-tcja and wayfair

Online CLE

A Whole New World: State Tax Post-TCJA and Wayfair

1.25 General CLE credits

From the Oregon State Bar CLE seminar 19th Annual Oregon Tax Institute, presented on June 6 and 7, 2019

© 2019 Stephen Kranz, Kathleen Quinn. All rights reserved.

Chapter 3

Presentation Slides: A Whole New World: State Tax Post-TCJA and Wayfair

Stephen KranzMcDermott Will & Emery LLP

Washington, D.C.

Kathleen QuinnMcDermott Will & Emery LLP

Washington, D.C.

Chapter 3—Presentation Slides: A Whole New World: State Tax Post-TCJA and Wayfair

3–ii19th Annual Oregon Tax Institute


3–119th Annual Oregon Tax Institute

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A WHOLE NEW WORLD: STATE TAX POST-TCJA AND WAYFAIROregon State Bar: Oregon Tax Institute June 6, 2019

Stephen Kranz Katie QuinnMcDermott Will & Emery McDermott Will & Emery (202) 756-8180 (212) [email protected] [email protected]

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AGENDA

• State Reponses to the Tax Cuts and Jobs Act– IRC Section 965 Transition Tax– GILTI and FDII– Domestic Provisions

• State Reponses to Wayfair

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STATE REPONSES TO THE TAX CUTS AND JOBS ACT

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STATE CONFORMITY WITH FEDERAL TAX LAW (GENERAL)

• Most states start with some version of federal taxable income as the starting point for state taxable income.

• Additions to and subtractions from federal taxable income are made to reflect differences between federal and state tax policies.– States often decouple from federal provisions that the states regard as

subsidies (e.g., accelerated depreciation). – If a state statute requires conformity to federal taxable income, the state

revenue department cannot decouple from a federal provision that it does not like. IBM Corp. v. Director, 26 N.J. Tax 102 (2011).

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IRC SECTION 965 TRANSITION TAX

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FEDERAL TAXATION OF DEEMED REPATRIATED FOREIGN EARNINGS

• IRC §965(a) provides for a one-time mandatory deemed repatriation of 30 years of accumulated foreign earnings.– The IRC §965 provisions were effective beginning in 2017. IRC §965(c) reduces the federal tax rate on repatriated earnings to 15.5% for

earnings of cash and cash equivalents and 8% for all other earnings.– For 2017, the transition tax was reported on a new federal form created

specifically for the one-time deemed repatriation and was not reported as part of the regular federal taxable income. But see treatment for 2018 – seemingly on Form 1120

– The transition tax can be paid in installments over eight years.

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REPATRIATION TRANSITION TAX: DETERMINING THE STATE AND LOCAL IMPACT

Overview of Issues• Impact of date of IRC conformity (see, for example, Arizona – adopts current

IRC for 2017, but not yet for 2018)• Assuming the state conforms to the IRC post TCJA, is income included in

federal income under IRC 965 included in the state tax base?– Deemed repatriated foreign earnings are included in income under the Subpart F

provisions, IRC 951(a), but are not technically defined as "Subpart F" income under IRC section 952

– Under this structure, such foreign earnings may not necessarily be excluded in states that do not tax subpart F income

• State tax policy reasons for inclusion/exclusion of 965 income

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REPATRIATION TRANSITION TAX: DETERMINING THE STATE AND LOCAL IMPACTOverview of Issues (cont.)• Application of the IRC § 965(c) deduction (intended to lower the federal tax rate).

– IRC § 965(c) deduction is not a “special deduction” so should be allowed in most states that tax foreign earnings deemed retreated under IRC 965

– Interplay with applicable dividend-received deductions

• Apportionment considerations – Potential inclusion of 965 income– Is there “factor relief” for the U.S. shareholder? If there is no statutory factor relief, such relief may nevertheless be required by the U.S.

Constitution? How would factor relief work? Remember, the 965 inclusion is of deemed repatriated earnings from

the past 30+ years.

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REPATRIATION TRANSITION TAX: DETERMINING THE STATE AND LOCAL IMPACT

Where to look for guidance on these issues:• Is state law clear, or in need of statutory or administrative clarification?• Are there any lurking constitutional questions, say with respect to Kraft

General Foods, Inc. v. Iowa Dep’t of Revenue, 505 U.S. 71 (1992)?

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REPATRIATION TRANSITION TAX: FLORIDA• The Florida Legislature updated conformity to the IRC to January 1, 2018• The Department’s Guidance

– Since 965 income is not reported on lines 1-10 of the Federal 1120, it does not “flow into” federal taxable income for most corporations and is, thus, excluded from the tax base

– Is this rational is correct?

• Florida’s dividends-received deduction: – "There shall be subtracted from such taxable income any amount to the extent included therein the

following… all amounts included in taxable income under s. 78 or s. 951 of the Internal Revenue Code. However, as to any amount subtracted under this subparagraph there shall be added to such taxable income all expenses deducted on the taxpayer's return for the taxable year which are attributable, directly or indirectly, to such subtracted amount.” Fla. Stat. § 220.13(1)(b)(2).

• The Department’s guidance suggests that the dividends-received deduction would apply to 965 income if it was included in federal taxable income.

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REPATRIATION TRANSITION TAX: NEW YORK

• Part KK of Chapter 59 of the Laws of 2018– Exemption for Subpart F income expanded to include deemed repatriated

income as a new type of exempt income, whether or not the deferred foreign income corporation is unitary

– Existing interest attribution applies Direct and indirect, or election to reduce exempt income by 40%

• Penalty relief

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REPATRIATION TRANSITION TAX: OREGON

• Oregon SB 1529– Provides that the gross, not the net, repatriation amount is included in the tax base, with

such gross amount subject to the dividends-received deduction of 70 or 80 percent, depending upon level of ownership.

– Ensures that taxpayers don’t receive double deduction. – Oregon had adopted tax haven legislation. ORS 317.716. As a result, Oregon may already

have taxed some of the income now deemed repatriated. To alleviate any double taxation, the bill allows a credit for taxes attributable to this income. The credit is limited to the lesser of the tax attributed to the repatriated income or the tax on the income included under ORS 317.716.

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REPATRIATION TRANSITION TAX: CONNECTICUT

• The Department of Revenue Services has issued guidance providing that the IRC 965 Income is considered a dividend for purposes of Connecticut's 100% dividend received deduction.– The guidance also provides that the 965(c) is disallowed.

• The Connecticut statue provides that expenses related to dividends are disallowed and that expenses related to dividends equals 5% of the dividends; thus, Connecticut effectively includes 5% of gross 965 income in the state tax base.

• Massachusetts has very similar treatment.

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REPATRIATION TRANSITION TAX: NEW JERSEY

• Under New Jersey law, the gross 965 income should be eligible for a 95% dividend-received deduction if the foreign subsidiary is at least 80% owned by the taxpayer.

• The gross 965 income should be eligible for a 50% deduction if the foreign subsidiary is at least 50% owned by the taxpayer.

• The New Jersey statute provides that the 965(c) deduction is disallowed.

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REPATRIATION TRANSITION TAX: NEBRASKA

• Nebraska has a dividends-received deduction for “dividends received or deemed to be received” from foreign corporations.

• The Nebraska Department of Revenue issued guidance providing that 965 Income is not a deemed dividend for purposes of this deduction.

• Is the Department’s position correct? – The Department has historically excluded Subpart F income as a deemed

dividend in the return instructions.– 965 Income is treated very similar to a dividend for federal income tax

purposes.– If 965 Income is not a deemed dividend, what is?

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GILTI AND FDII

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GILTI (GLOBAL INTANGIBLE LOW-TAXED INCOME)

• Purpose: to discourage U.S. companies from retaining business operations in low-tax foreign countries or, alternatively, from moving such operations there.

• Federal rule:– U.S. shareholders must include in income certain income of controlled foreign corporations

that is taxed abroad at a rate lower than the U.S. tax rate and that exceeds a 10% return on the CFCs’ tangible property. IRC § 951A.

– U.S. shareholder that is a C-corporation can deduct 50% (or 37.5% after 2025) of its GILTI (thereby reducing the effective tax rate). IRC § 250(a)(1)(B).

– Partial foreign tax credit allowed to lessen tax imposed on GILTI in an effort to tax only income generated in low-tax jurisdictions.

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GILTI: DETERMINING THE STATE AND LOCAL IMPACTOverview of Issues• Impact of date of IRC conformity• Assuming the state conforms to the IRC post TCJA, is GILTI included in state income?

– Note: new IRC § 951A has been included in the subpart F provisions of the Code and GILTI is treated as Subpart F income under certain provisions of the Code but GILTI is technically not Subpart F income For example, GILTI is not determined with respect to a CFC’s earnings & profits (i.e., unlike Subpart

F income) – Under this structure, GILTI is not necessarily excluded in states that do not tax Subpart F income

• State tax policy reasons for inclusion/exclusion of GILTI

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GILTI: DETERMINING THE STATE AND LOCAL IMPACT

Overview of Issues (cont.)• Application of the IRC § 250 federal deduction (intended to lower the federal

tax rate)• Apportionment considerations

– Potential inclusion of GILTI Net of 250 deduction? Subsequent of any state dividend-received deduction?

– Is there “factor relief” for the U.S. shareholder? If there is no statutory factor relief, such relief may nevertheless be required by the U.S.

Constitution? How would factor relief work?

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GILTI: DETERMINING THE STATE AND LOCAL IMPACT

Where to look for guidance on these issues:• Is state law clear, or in need of statutory or administrative clarification?• Is there a possibility that state law may be changed (i.e., a

reconsideration of prior policy)?• Are there any lurking constitutional questions, say with respect to Kraft

General Foods, Inc. v. Iowa Dep’t of Revenue, 505 U.S. 71 (1992)?

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GILTI: GEORGIA

• Georgia H.B. 918 (Enacted on March 2, 2018)– This conformity bill did not provide for an exclusion from the tax base for

GILTI, although the IRC § 250 deduction was allowed. In addition, the bill provided that the Georgia DRD did not apply to GILTI.

• Georgia SB 328 (Enacted on March 26, 2018)– Due to pressure from the business community, this bill provided that GILTI

was treated as Subpart F income and excluded from the tax base.

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GILTI: WISCONSIN

• Wisconsin Act 231– Specifically decouples with GILTI provisions of the Tax Cuts and Jobs Act

(P.L. 115-97).– Accordingly, neither the GILTI addition nor the deduction are included in the

starting point for computing the Wisconsin tax base.

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GILTI: KENTUCKY

• Tech. Advice Memo (KY-TAM-18-02) – Kentucky does not tax dividend income, including Subpart F– GILTI “treated similarly to Subpart F income” for federal purposes– GILTI is, therefore, non-taxable for Kentucky purposes– 250 deduction is not allowed– Provides for add back of related expenses

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GILTI: NEW JERSEY

• A. 4495 (Oct. 4, 2018)– Under legislation passed in October 2018, New Jersey includes GILTI in the state tax base

and allows the IRC section 250 deduction, essentially taxing 50% of GILTI.

• Tax Bulletin TB-85(R)– GILTI is not treated as a dividend or deemed dividend, and therefore not subject to the

state’s dividends received deduction – The allocation factor for computing the tax on net GILTI is equal to a ratio of: (1) New Jersey’s gross domestic product (GDP) over (2) the total GDP of every US state (and DC) in which the taxpayer has economic nexus

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GILTI: OREGON

• TBD– The Oregon Senate Finance & Revenue Committee has released two draft

bills concerning the state’s taxation of GILTI. With respect to GILTI, both drafts are the same and both would treat GILTI as a

dividend for purposes of the 70-80% DRD and provide an addback for the GILTI deduction. Factor relief is unclear.

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FDII DEDUCTION (DEDUCTION FOR FOREIGN DERIVED INTANGIBLE INCOME)

Purpose: to incentivize U.S. companies to keep business operations and assets in the U.S.• Domestic corporations get a deduction from income for 37.5 percent of

their foreign derived intangible income.• This is a special deduction under the IRC.

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FDII: DETERMINING THE STATE AND LOCAL IMPACT

Overview of Issues• Impact of date of IRC conformity• Assuming the state conforms to the IRC post TCJA, is the FDII deduction

included in state income?– Does the state conform to federal taxable income, before or after special deductions? – The FDII deduction is included in the computation of federal taxable income so if a state’s

starting point is federal taxable income, as defined in IRC sec. 63, the FDII deduction should be allowed absent a specific modification.

– Look at the statutes, not only the forms!

• If a state excludes GILTI from the tax base, that does not mean that the FDII deduction is automatically disallowed. FDII and GILTI are different!

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FDII: NEW JERSEY

• Tax Bulletin TB-85(R)– FDII is allocated to New Jersey in the same manner as GILTI.– The allocation factor for computing the tax on FDII is equal to a ratio of: (1) New Jersey’s gross domestic product (GDP) over (2) the total GDP of every US state (and DC) in which the taxpayer has economic nexus

• Does this allocation make sense? – FDII is not a new category of income in the New Jersey tax base.– Should FDII be allocated any differently than domestic sales? – Constitutional issues.

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DOMESTIC PROVISIONS-163(j) Limitations-Other Notable Domestic Provisions

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INTEREST DEDUCTION LIMITATION

• IRC §163(j)provides a new limitation on a taxpayer’s ability to deduct interest expense– A taxpayer generally cannot deduct business interest expense for a taxable year to the extent that

such interest exceeds the sum of (a) the taxpayer’s business interest income, and (b) 30% of the taxpayer’s adjusted taxable income (ATI) for such taxable year. Business interest expense means any interest paid or accrued on indebtedness properly allocable

to a trade or business and business interest income means any interest includible in the gross income of the taxpayer which is properly allocable to a trade or business.

ATI means the taxable income of the taxpayer computed without regard to (1) any item of income, gain, deduction, or loss which is not properly allocable to a trade or business, (2) any business interest expense or business interest income, (3) any NOL deduction under Section 172, (4) any deduction allowable under Section 199A, (5) for taxable years beginning before January 1, 2022, any deduction allowable for depreciation, amortization, or depletion.

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INTEREST DEDUCTION LIMITATION: STATE ISSUES

• Purpose of federal rule: to prevent double tax benefit when coupled with expensing.

• If states do not adopt the federal expensing regime, arguably they should not limit interest deductions.

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INTEREST DEDUCTION LIMITATION: STATE ISSUES

• In most states, the corporate income tax base is based on a taxpayer’s federal taxable income.

• Interaction with related-party addback provisions. • Will state allow indefinite carryforward of disallowed interest expense?

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INTEREST DEDUCTION LIMITATION: STATE ISSUES• In separate return states, a different computation will be needed to determine

the interest limitation for each corporate taxpayer that files within the state. • In combined-filing states the state combined group may not be the same as

the federal consolidated group, thus resulting in the need for additional interest expense limitation computations to adjust for differences between the federal and state groups.

• Approaches:– Separate computation at state level– Allocation of federal limitation among members of the consolidated group – but

based on what? • Pennsylvania and New Jersey issued guidance

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OTHER NOTABLE DOMESTIC PROVISIONS

• IRC Sec. 118 -- requires contributions of capital to be included in gross income if made as a “contribution to construction” or by “a customer or potential customer,” from “governmental entities” and “civic groups” (other than contributions “made by a shareholder as such”), with limited grandfather exception

• Expensing provisions -- Current bonus depreciation percentage under IRC §168(k) is increased from 50% to 100% for property acquired and placed in service after September 27, 2017, and before December 31, 2022. The 100% expensing is phased down by 20 percentage points per calendar year beginning in 2023.

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STATE REPONSES TO SOUTH DAKOTA V. WAYFAIR

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NATIONAL BELLAS HESS TO WAYFAIR

2019

Today

1967 1973 1979 1985 1991 1997 2003 2009 2015

National Bellas Hess imposes physical‐presence requirement for nexus

6/1/1967

North Dakota Cent.Code sec. 57‐40.2‐07 goes into effect‐‐challenging physical‐presence requirement

7/1/1987

Quill upholds physical‐precense requirement for nexus

6/1/1992

Congressional Advisory Committee on E‐Commerce recognizes need for reform

2/1/2000

Justice Kennedy calls for reconsideration of Quill in DMA

3/3/2015

Court grants cert in Wayfair

1/12/2018

Court overturns Quill physical‐presences test in Wayfair

6/21/2018

1/2/1973 7/1/2018Various federal legislative proposals introduced

1/1/2000 7/11/2018Streamlined Sales and Use Tax Agreement

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STATES TAKE THINGS INTO THEIR OWN HANDS…

2019

Today

2005 2007 2009 2011 2013 2015 2017

California's agency/affiliate nexus statute upheld in Borders Online LLC

5/30/2005

New York's "click‐through" nexus statute upheld in Overstock.com/Amazon.com

3/28/2013

Massachusette's imposes "cookie" nexus standard by regulation

9/13/2017

Colorado passes H.B. 1193, which imposes "use tax notification and reporting" on remote sellers not collecting sales tax

2/24/2010

Alabama imposes "economic nexus" standard by regulation on remote sellers

1/1/2016

South Dakota passes S.B. 106, which imposes economic nexus standard for remote seller collection

5/1/2016

Washington's Marketplace law goes into effect

1/1/2018



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SOUTH DAKOTA V. WAYFAIR

Background•South Dakota adopted an economic nexus standard for sales and use tax purposes

– Any seller with sales exceeding an annual threshold of $100,000 or 200 or more separate transactions in South Dakota was required to collect and remit effective May 1, 2016

– Physical presence was not required

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SOUTH DAKOTA V. WAYFAIROn June 21, 2018, the Court ruled in a 5-4 decision to overturn the Quill physical presence standard for sales tax nexus•The Court concluded that the physical presence rule set forth in Quill is overruled because it was “unsound and incorrect”•The Court said that the physical presence rule “has been the target of criticism over many years from many quarters”

– “Quill is flawed on its own terms. First, the physical presence rule is not a necessary interpretation of the requirement that a state tax must be applied to an activity with a substantial nexus with the taxing state. Second, Quill creates rather than resolves market distortions. Third, Quill imposes the sort of arbitrary, formalistic distinction that the Court’s modern Commerce Clause precedents disavow” (emphasis added)

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• Instead of Quill’s physical presence rule, the appropriate test is whether the taxpayer “avails itself of the substantial privilege of carrying on business” in a jurisdiction

• The taxpayers had substantial nexus with South Dakota– The taxpayers at issue, large retailers with extensive virtual presence,

clearly availed themselves of the substantial privilege of carrying on business in South Dakota

• The case was remanded to South Dakota to determine whether South Dakota’s law was otherwise consistent with the Commerce Clause

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• South Dakota’s law included several features that appear designed to prevent discrimination or undue burdens upon interstate commerce– No retroactivity– Member of Streamlined Sales and Use Tax Agreement– Minimum threshold

• Other Commerce Clause precedents will protect against any undue burden on interstate commerce– Pike balancing test – is the burden imposed on interstate commerce clearly excessive in relation to the

putative local benefits– Retroactive liability creates a double-taxation risk– Small sellers can still argue there is a burden or the presence is de minimis

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STATE RESPONSES TO WAYFAIR– Most states have already taken legislative and regulatory action adopting nexus standards

aimed at remote retailers– States with laws on their books can immediately begin requiring remote sellers to register

and collect tax on sales to in-state customers Will they give companies lead time to adopt new systems and procedures? Most have.

– Will states offer amnesty/voluntary disclosure programs for remote retailers?

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POST-WAYFAIR RAMIFICATIONSWinners•States•Localities (?)•Bricks and mortar retailers•Software compliance companies•Foreign sellers (?)

Losers

Online retailers

Start-ups

Marketplace providers

Foreign sellers (?)

Service providers

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PLANNING FOR SELLERS - LOCALITIES• The Wayfair decision did not address enforcement by localities. • The majority decision specifically referenced South Dakota’s membership in the

Streamlined Sales and Use Tax Agreement as one of the reasons the imposition was not an undue burden.

• One of SST’s key features is a ‘one-stop shop’ for registration, return filing, and audits of sellers. SST members do not have local enforcement or compliance requirements for sales and use taxes. – Louisiana, which has extensive local enforcement, stated that it was reviewing its options to

enable single-state administration by January 1, 2019.– Colorado Sales and Use Tax Simplification Task Force actively considering potential

simplification efforts for 2019 legislation.

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STATE RESPONSE – SIMPLIFICATION• For those states that are not members of the Streamlined

Sales and Use Tax Agreement, the NCSL SALT Task Force recommended the following simplifications:– Simplification of registration for sellers– Establish, centralize and simplify a process for sellers to use

Certified Software Providers for compliance– Provide publicly available taxability and exemption tables and

update regularly– Provide a publicly available rate and boundary database and

update regularly

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MARKETPLACE PROVIDER LAWS• Requires “marketplace providers” to collect tax on sales made by third party

sellers or comply with notice requirements• States have specific definitions of “marketplace providers”

– Washington: “Marketplace facilitator” means a person that: (i) Contracts with sellers to facilitate for consideration, regardless of whether deducted

as fees from the transaction, the sale of the seller's products through a marketplace owned or operated by the person;

(ii) Engages directly or indirectly, through one or more affiliated persons, in transmitting or otherwise communicating the offer or acceptance between the buyer and seller. For purposes of this subsection, mere advertising does not constitute transmitting or otherwise communicating the offer or acceptance between the buyer and seller; and

(iii) Engages directly or indirectly, through one or more affiliated persons, in any of the following activities with respect to the seller's products: (A) Payment processing services; (B) Fulfillment or storage services; (C) Listing products for sale; (D) Setting prices; (E) Branding sales as those of the marketplace facilitator; (F) Taking orders; or (G) Providing customer service or accepting or assisting with returns or exchanges.

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STATES WITH MARKETPLACE PROVIDER LAWS

• Alabama – eff. January 1, 2019• Arkansas – eff. July 1, 2019• California – eff. October 1, 2019• Connecticut – eff. December 1, 2018• District of Columbia – eff. April 1, 2019• Hawaii – eff. January 1, 2020• Idaho – eff. June 1, 2019• Indiana – eff. July 1, 2019• Iowa – eff. January 1, 2019• Kentucky – eff. July 1, 2019• Minnesota – eff. October 1, 2018• Nebraska – eff. April 1, 2019• New Jersey – eff. November 1, 2018• New Mexico – eff. July 1, 2019

• New York – eff. June 1, 2019• North Dakota – eff. October 1, 2019• Oklahoma – eff. July 1, 2018• Pennsylvania – eff. April 1, 2018• Rhode Island – eff. June 27, 2019• South Carolina – eff. April 26, 2019• South Dakota – eff. March 1, 2019• Utah – eff. October 1, 2019• Virginia – eff. July 1, 2019• Washington – eff. January 1, 2018• West Virginia – eff. July 1, 2019• Wyoming – eff. July 1, 2019

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As of May 22, 2019, the following states enacted a marketplace provider law:



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NON-SALES TAX ISSUES

• Corporate Income Tax– Could this expand concept of water’s-edge? Foreign company with no sales in a state but with substantial business activities –

such as with an affiliate or a third-party supplier Benefit or harm?

• Personal Income Tax Withholding

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a whole new world: state tax post-tcja and wayfair

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