salt implications of federal tax reform

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SALT Implications of Federal Tax Reform

March 19, 2018 Aaron PaynePartner

Todd BetorAssociate

TEI Richmond Chapter

Eversheds Sutherland

− H.R. 1 – Tax Cuts and Jobs Act (“TCJA”)

− State Conformity: The Gating Question

− Tax Rates, AMT Elimination, & NOL Limitations

− Interest Deduction Limitation: IRC 163(j)

− Full Expensing for Five Years: IRC 168(k)

− Foreign-Source Dividend Received Deduction (“DRD”)

− Transition Tax on Foreign Deferred Income

− Global Intangible Low-Taxed Income (“GILTI”)

− Foreign-Derived Intangible Income (“FDII”)

− Base Erosion and Anti-Abuse Tax (“BEAT”)

Overview

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TCJABackground


TCJA: Background

─ On November 2, 2017, the House Ways and Means Committee released H.R. 1, the Tax Cuts and Jobs Act (the “House Bill”).

─ On November 10, 2017, the Senate Finance Committee released the description of the Chairman’s markup on the Tax Cuts and Jobs Acts (the “Senate Bill”).

─ On November 16, 2017, the House of Representatives passed the House Bill.

─ On December 2, 2017, the Senate passed the Senate Bill.─ Given the substantive differences between the House Bill and the

Senate Bill, a conference committee was convened to negotiate a bill agreeable to both houses.

─ On December 15, 2017, the conference committee reported what would become the Final Bill.

─ By December 20, 2017, the Senate and the House of Representatives passed the Final Bill.• As a result of a ruling by the Senate parliamentarian, the official title of the Final Bill was changed

from the Tax Cuts and Jobs Act to “The Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”

─ On December 22, 2017, President Trump signed the Final Bill into law.

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State Conformity:The Gating Question


State Conformity: The Gating Question

─ The gating question as to the SALT impact from the TCJA will be whether and how a state conforms to the IRC.

─ States generally fall within three regimes in terms of how they conform to the IRC:• (1) states that adopt the provisions of the IRC in real time

(“rolling” conformity states). For example, Maryland bases its corporate income tax on “the corporation’s federal taxable income for the taxable year as determined under the Internal Revenue Code … .” Md. Code Ann., Tax-Gen. § 10-304(1).

• (2) states that conform to the IRC as of a static or fixed date (“fixed” conformity states). For example, until recently New Hampshire conformed to the IRC in effect as of December 31, 2000. N.H. Rev. Stat. Ann. section 77-A:1.XX.(1).

• (3) states that pick and choose different provisions of the IRC (“selective” conformity states). (See, e.g., Ark. Code Ann. § 26-51-404 et seq.).

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7

AK

HI

ME

VTNH

MANYCT

PA

WV

NC

SC

GA

FL

IL OHIN

MIWI

KY

TN

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

ORID

NV

CAVA

MD

As of March 13, 2018

TX’s conformity date is January 1, 2007.

RI

NJ

DE

DC

WA

KeyFixed

Rolling

Selective

No income tax

State Corporate Income Tax Conformity to the IRC



─ Examples of recent state conformity changes:• Georgia – conforms to the IRC as in effect on February 9, 2018.

• See Georgia H.B. 918 (2018).• Idaho – for tax years that begin after 2016, conforms to the IRC

as in effect on January 1, 2018.• See Idaho H.B. 463 (2018).

• Michigan – conforms to the IRC as in effect on January 1, 2018, or at the taxpayer’s option.

• See Michigan S.B. 748 (2018).• Virginia – conforms to the IRC as in effect on February 9, 2018.

• See Virginia S.B. 230 (2018).• West Virginia – conforms to the IRC and all amendments made

between December 31, 2016, and January 1, 2018.• See West Virginia H.B. 4135 (2018).

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Tax Rates, AMT Elimination, & NOL Limitations


Tax Rates, AMT Elimination, & NOL Limitations

─ Reduced Corporate Tax Rate (IRC § 11)• The corporate tax rate is reduced from 35% to 21% for tax years beginning after

December 17, 2017.• 80% and 70% DRDs are reduced to 65% and 50%, respectively, for tax years beginning after

December 31, 2017 to reflect the lower corporate tax rate.

─ Elimination of the Corporate Alternative Minimum Tax (“AMT”) (previously IRC § 55)• The corporate AMT is repealed for tax years beginning after December 31, 2017.

─ Reduced Rate for Certain Pass-Through Income (IRC § 199)• Generally allows a taxpayer other than a corporation to deduct 20% of the

taxpayer’s “qualified business income” and certain other income (subject to limitation based on the type of business and the taxpayer’s taxable income for the tax year), resulting in a reduced effective rate of tax on such income.

─ NOL Limitations• For losses arising in tax years beginning after December 31, 2017, NOL deductions

are limited to 80% of taxable income.• Unused NOLs may be carried forward indefinitely.• NOL carryforwards from prior years are not subject to the 80% limitation.

• For losses arising in tax years beginning after December 31, 2017, the two-year carrybacks of NOLs is generally eliminated.

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Interest Deduction Limitation:IRC § 163(j)


Interest Deduction Limitation: IRC § 163(j)

─ New IRC § 163(j) limits a taxpayer’s business interest expense deduction to 30% of the taxpayer’s adjusted taxable income plus the taxpayer’s business interest income and floor plan financing interest.

─ Adjusted taxable income does not include:• Any income, gain, loss, or deduction not allocable to a trade or

business;• Any business interest or business interest income;• Any NOL under IRC § 172;• Any deduction for “qualified business income” under IRC § 199A;• Any deduction allowed for depreciation, amortization, or depletion for

tax years beginning before 2022; and• Other adjustments provided by the Secretary.

─ While the final iteration of the TCJA is silent, the explanation provides that IRC § 163(j) is intended to apply at the consolidated group level.

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SALT Implications

─ Separate filing states?• How do you determine the entity limitation?

─ Combined filing states?• Limitation calculated at the combined group level?

─ Planning opportunities?

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Full Expensing for Five Years:IRC § 168(k)


Full Expensing for Five Years: IRC § 168(k)

─ Expands bonus depreciation, permitting taxpayers to elect, on an asset-by-asset basis, to fully expense the cost of both new and used “qualified property” acquired and placed in services after September 27, 2017, and before January 1, 2023.

• The bonus depreciation rate is phased down for such property placed in service after December 31, 2022 to zero in 2027 and thereafter.

• Generally maintains the current bonus depreciation rates for qualified property acquired before September 28, 2017 and placed in service after September 27, 2017.

• A taxpayer may elect to apply a 50% allowance instead of the full 100% allowance during its first tax year ending after September 27, 2017.

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SALT Implications

─ State impact may be minimal as most states historically have “decoupled” from bonus depreciation.

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Foreign-Source DRD:IRC § 245A


Foreign-Source DRD: IRC § 245A

─ A 100% DRD is available for dividends received by a domestic corporation that is a U.S. shareholder from a specified 10%-owned foreign corporation.• A specified 10%-owned foreign corporation generally is a foreign

corporation in which a domestic corporation is a U.S. shareholder.• Permits the DRD with respect to deemed dividend distributions under

IRC § 1248 on sales of stock of CFCs.• The DRD is not available for “hybrid dividends” from controlled

foreign corporations (“CFCs”) – e.g., where a CFC receives a tax deduction with respect to such dividend.

• 365-day holding period requirement.

─ Reduces the basis in stock in foreign corporations to reflect distributions eligible for DRD in calculating losses.

─ Requires recapture of net losses of a foreign branch that is transferred to a foreign corporation – an expansion of existing branch loss recapture rules.

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SALT Implications

─ 100% foreign-source DRD is nothing new for multinational corporate state taxpayers. • This treatment largely stems from the U.S. Supreme Court’s decision

in Kraft General Foods, Inc. v. Iowa Department of Revenue, 505 US 71, 112 S. Ct. 2365 (1992).

─ Unlike the transition tax, the foreign-source DRD falls within the IRC’s “special deductions.” • Whether the starting point for calculating the state tax base is line

28 or a subsequent line of a corporation’s federal tax return, Form 1120 is critical to determining the state impact of the foreign-source DRD.

─ States that do not otherwise provide for a DRD for foreign dividends received may also not conform to the new IRC § 245A or enact legislation to decouple. • However, as with the calculation of the transition tax, any differing

treatment between domestic and foreign dividends will likely face constitutional scrutiny under Kraft.

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Transition Tax:IRC § 965


Transition Tax: IRC § 965

─ Imposes a one-time transition tax on a U.S. shareholder with respect to its investment in CFCs and certain other foreign corporations.

─ Imposed on the net aggregate amount of the U.S. shareholder’s pro rata shares of the previously untaxed foreign earnings and profits (“E&P”) of such CFCs and other foreign corporations.• Effective rate of 15.5% on the amount of cash and cash equivalents,

and• 8% for any amount in excess.

─ Taxpayers are able to elect to pay any resulting liability over an eight-year period.

─ The measurement date for applying the transition tax is either November 2, 2017, or December 31, 2017, depending on which date the undistributed E&P of the specified foreign corporation is greater.

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Transition Tax: IRC § 965

─ IRS Notice 2018-07 provides limited guidance with respect to the E&P impact of amounts paid between specified foreign corporations between testing dates and distributions to specified foreign corporations.

─ Permits intragroup netting among U.S. shareholders in an affiliated group, so that deficits in one specified foreign corporation can offset the inclusions in another specified foreign corporation, even if they do not have the same U.S. shareholder. • Notice 2018-07 indicates that the IRS intends to issue regulations

treating all members of a consolidated group that are U.S. shareholders as a single U.S. shareholder for this purpose.

─ Foreign tax credits (“FTCs”) are permitted with respect to the taxable portion of the inclusion, and the IRC § 78 gross-up amount equals the total foreign income taxes multiplied by a fraction, the numerator of which is the taxable portion and the denominator of which is the total inclusion.

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SALT Implications

─ Impact is largely based on:• Whether the associated deduction for amounts of the transition tax

are considered “special deductions” for federal income tax purposes.• Because the IRC describes special deductions as those deductions set forth in

IRC §§ 243-250, it appears that the transition tax deduction in IRC § 965 should be taken prior to Form 1120 line 28.

• State treatment of subpart F income.• For example, Florida and Georgia exclude subpart F income from taxable

income, net of expenses. Fla. Stat. § 220.13(1)(b)(2); Ga. Code § 48-7-21(b)(8)(A)(ii).

• But, for example, California does not conform to the federal treatment of subpart F income. Rather, California requires water’s-edge filers to include a portion of their CFC’s income in the water’s-edge return. Cal. Rev. & Tax. Cd. § 25110(a)(2)(A)(ii).

• Taxpayers’ state income tax filing method – worldwide combined, water’s-edge, or separate.

─ Timing—States traditionally do not afford a similar payment deferral mechanism as allowed for federal income tax purposes, thus taxpayers will have to currently recognize and take into income the net inclusion of the transition tax.

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SALT Implications

─ Conforming states may run afoul of Kraft.• Because the transition tax requires an inclusion with respect to

foreign subsidiaries while there is not a similar income inclusion with respect to domestic subsidiaries, a state’s conformity to the transition tax will likely face constitutional scrutiny under Kraft.

• In Kraft, the U.S. Supreme Court found that Iowa’s inclusion of dividends from foreign subsidiaries, but not from domestic subsidiaries, in a taxpayer’s apportionable income tax base unconstitutionally discriminated against foreign commerce. Iowa’s discrimination was based on the state’s conformity to the federal corporate income tax scheme, however, the Court held that “the Iowa statute cannot withstand scrutiny … for it facially discriminates against foreign commerce and therefore violates the Foreign Commerce Clause.”

─ Factor representation - Is the inclusion of foreign (deemed) dividends, but not including the corresponding apportionment factors of the specified foreign corporations unconstitutionally discriminatory?• See, e.g., Caterpillar, Inc. v. Commissioner of Revenue, 568 N.W.2d

695 (Minn. 1997), cert. denied, 522 US 112, 118 S. Ct. 1043 (1998).

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GILTI:IRC §§ 951A and 250


GILTI: IRC §§ 951A and 250

─ Imposes tax on a U.S. taxpayer’s GILTI: CFC income in excess of a proxy for routine returns on tangible property (measured based on adjusted tax basis).

─ A 50% deduction for such income is provided, generally resulting in a U.S. tax rate of 10.5% for such income.• For tax years beginning after December 31, 2025, the deduction is

reduced to 37.5%.

─ FTCs are permitted for 80% of the foreign taxes paid with respect to such income. As a result, for a taxpayer able to utilize all available FTCs, GILTI generally will not be subject to residual U.S. tax if the average foreign tax rate imposed on such income is at least 13.125%.

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SALT Implications

─ Base broadening?

─ Because IRC § 951A is a new section, states will not have a specific exclusion for GILTI.• Will states treat GILTI like subpart F income?

• Georgia – amended its law to specifically tax GILTI, whereas subpart F income is excluded from income. See Georgia H.B. 918 (2018).

─ IRC § 250 is considered a “special deduction,” thus the impact of the corresponding deduction in IRC § 250 is largely dependent on states’ starting point for calculating state taxable income:• Form 1120

• Line 28 – income before NOLs and special deductions• Line 30 – income after NOLs and special deductions

─ State use of FTCs?

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SALT Implications

─ The impact of GILTI will be affected by a taxpayer’s state income tax filing method.

─ Kraft issues.• Because the GILTI provisions require an inclusion with respect to

foreign subsidiaries while there is not a similar income inclusion with respect to domestic subsidiaries, a state’s conformity to GILTI will likely face constitutional scrutiny under Kraft.

─ Factor representation—Is the inclusion of foreign (deemed) dividends, but not including the corresponding apportionment factors of the CFCs unconstitutionally discriminatory?

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FDII:IRC § 250


FDII: IRC § 250

─ Provides a 37.5% deduction for certain income earned in the U.S. attributed to foreign exploitation of U.S.-held intangibles.

• Results in a reduced effective tax rate on covered income of 13.125%, subject to a taxable income limitation.

• Deduction is reduced from 37.5% to 21.875% for tax years beginning after December 31, 2025.

─ FDII is calculated in a manner similar to GILTI.

• Generally equal to all income earned in the U.S. in excess of a proxy for routine returns on tangible property (measured based on adjusted tax basis) multiplied by the fraction of income earned in the U.S. that is attributable to property sold to a non-U.S. person for foreign use or attributable to services provided outside the U.S.

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SALT Implications

─ Deduction for FDII under IRC § 250 is a “special deduction,” thus the impact (benefit) is largely dependent on whether a state’s starting point for calculation of state taxable income is Form 1120 line 28 or line 30.

─ The impact of FDII will be affected by a taxpayer’s state income tax filing method.

─ Selective decoupling – FDII, as enacted, is to work with GILTI.

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BEAT:IRC § 59A


BEAT: IRC § 59A

─ Generally imposes a 10% minimum tax (5% in 2018) on a taxpayer’s income determined without regard to tax deductions arising from base erosion payments.• For tax years beginning after December 31, 2025, the rate increases

to 12.5%. For affiliated groups that include a bank or securities dealer, the rates are increased by 1%.

• Such tax deductions generally cannot be reduced by credits other than the R&D credit and, until 2025, 80% of certain renewable energy credits and the low income housing credit.

─ Base erosion payments: generally amounts paid by a taxpayer to a related foreign person that are deductible to the taxpayer (including interest) or that create depreciable or amortizable asset basis.• Certain exceptions include payments on which withholding tax is

imposed and withheld, certain no-mark-up services eligible for the services cost method (not including business judgment rule) and “qualified derivative payments.”

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BEAT: IRC § 59A

─ The BEAT applies to U.S. corporations (other than RICs, REITs, or S corporations), which have average annual gross receipts of at least $500 million for the preceding three tax years and which have a base erosion percentage (generally, deductible payments to foreign affiliates over total deductions) of 3% (2% for affiliated groups that include a bank or securities dealer) or higher for the tax year.

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SALT Implications

─ The federal impact of the BEAT is the payment of additional tax for those taxpayers subject to it.

─ Because the BEAT is a separate tax that does not go into the calculation of federal taxable income, the BEAT currently does not have an impact on state taxable income.

─ Taxpayers should stay on the lookout for what states will do with the BEAT.

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Questions

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