Eye on Tax Reform: Why State and Local Taxes Matter a Lot This Year
With federal tax reform getting so much attention, the impact of tax reform on state and local taxes may go unnoticed. However, state and local taxes (“SALT”) are where taxpayers may feel unexpected pain.
Lots of people have the misconceptions that:
- State taxes are simple
- The impact of state taxes will be insignificant to your bottom line
- There’s nothing you can do to reduce your states taxes
Actually, those businesses and individuals who recognize and proactively plan for the state impacts of federal tax reform will be best positioned to minimize the negative effects of changes in the tax laws and to maximize the opportunities.
Why SALT Matters – and What to Look For
States are still in the process of evaluating and responding to the changes triggered by the passage of the Tax Cuts and Jobs Act (“TCJA”), especially since many states are just now entering their annual legislative sessions.
The degree to which state taxes will be impacted by tax reform at the federal level will depend on the degree to which each state decides to base its tax calculations on the new tax law.
Most states choose to conform their state taxable income calculation to the Internal Revenue Code (“IRC” or “Code”) to some degree. Having consistency between the Code and state tax law usually makes filing easier for taxpayers and boosts compliance.
States can choose rolling conformity, where they automatically adopt IRC changes as currently in effect, or fixed-date conformity, where they choose to adopt IRC changes on a specific date. Their third choice is not to conform to certain provisions, or to decouple from the IRC. Fixed-date states generally update their conformity or make their decoupling modifications during the state’s annual legislative session.
In general, the federal changes broaden the tax base and reduce tax rates. Because states don’t adopt the federal tax rates but do adopt significant aspects of the IRC, the result may be a higher state tax liability for many taxpayers.
Another consideration is that states have balanced budget requirements that the federal government doesn’t have. So, states are scrambling to evaluate and respond to the changes made in the TCJA to see how their own budgets will be affected. In the end, there’s likely to be significant activity during this spring’s state legislative season.
Who Is Affected Most?
The question of state tax conformity affects taxpayers across the spectrum. However, some categories of taxpayers are more vulnerable to the effects of the new provisions.
- Small businesses. Choice of business entity (i.e., C corporation, S corporation, partnership, sole proprietorship, etc.) will be more important than ever, since state tax rates can be as high as 12 percent with several states falling in the 8-10 percent range. How your business is structured will also determine whether or not you can take advantage of specific deductions in the TCJA or if you’ll be subject to new taxation provisions.
- Multinational businesses. States must determine if the new federal repatriation provisions, including the global intangible low-taxed income (“GILTI”) rule and the foreign derived intangible income (“FDII”) provision, will be included in the state taxable income calculation. Multinational businesses will need to watch for developments in the states where they operate.
- Businesses making significant capital investments. Some capital purchases may qualify for the new 100-percent expensing provisions. However, will states offer the same bonus depreciation, or will businesses find themselves maintaining two different fixed-asset ledgers – one for federal tax and one for state taxes? How will state decoupling impact your overall tax liability? What is the impact on property taxes?
- Businesses that are relocating. Make sure to evaluate state incentives related to relocating your business operations to be sure that their value is not impacted by the new federal tax law.
- Businesses with net operating loss (“NOL”) carryovers. Since rules for NOLs are changing at the federal level, you’ll want to be sure you know how to handle them on your state taxes, too. Do the states where you operate conform to the federal NOL changes? In what other ways does the federal tax reform impact your state NOLs?
If taxpayers make big business decisions about things such as choice of entity and capital investments based solely on federal tax law changes, they may find later that their choices have a negative impact on their state taxes – and that the liability may have been avoidable with proper planning.
When considering business changes, make sure to “add a little SALT.” Stay in touch with your Cherry Bekaert advisor about the state and local tax impact on your own situation – or reach out to a local advisor today to start the conversation if you have questions. The professionals on the Cherry Bekaert SALT team will be watching developments closely as states and local jurisdictions make decisions about tax reform, so stay tuned and stay in touch to get answers.
On-demand Video: Federal Tax Reform and Its Impact on State and Local Taxation
Get more details from this live recording of our SALT webinar from February 20, 2018.