STATE FEDERAL CONFORMITY ISSUES

Transcription

1 Tax Executives Institute Houston Texas February 21, 2017 STATE FEDERAL CONFORMITY ISSUES Jordan M. Goodman, Partner Marilyn A. Wethekam, Partner Horwood Marcus & Berk, Chicago IL 1

2 Agenda Policy Considerations Definition of Taxable Income Basic Issues: Non-conformity Tax Base Foreign Source Income Depreciation IRC Section 199 Net Operating Losses Consolidated Return Regulations: Basis Issues Deferred Transaction Group Composition Loss Limitations 2

3 Policy Considerations 3

4 Why Non-Conformity? Revenue raising Administrability Economic stability Equality/horizontal equity Economic inequality/vertical equity Neutrality/free market Political order 4

5 Definition of Taxable Income 5

6 Definition of Taxable Income The moving (piggyback) federal tax base: Some states income tax laws define terms by reference to the IRC as it exists for the current taxable year; The static federal tax base: Some states income tax laws define terms by reference to the IRC as of a specific date; or Adopt only specific IRC provisions. Starting point is federal taxable income 6

7 Basic Issues 7

8 Non-Conformity Tax Base Federally deferred income: IRC Sec. 311(b) provides that certain distributions of appreciated property trigger income that is recognized by the dividend payor, Exception: if the distribution is an intercompany transaction, in which case the gain is deferred. 8

9 Non-Conformity Tax Base Domestic dividends IRC section 243 provides for a deduction for dividends received from domestic corporations 100% requires at least 80% common ownership 80% owns 20% or more of the stock 70% owns less than a 20% stock interest State taxation of REITs 9

10 Non-Conformity Tax Base State taxation of foreign-source income IRC 61, gross income means all income from whatever source derived IRC sec. 245 provides for a DRD: From a 10% owed foreign corporation to the extent of the U.S. source portion of the dividends; Equal to 100% of the dividends received gross income from all sources is U.S. and Equal to 100% of the dividends received from a foreign sales corporation (FSC). State prohibited from discriminating against foreign commerce. Treatment of foreign dividends. 10

11 Depreciation Federal law Code Section 167 allows for depreciation deductions Accelerated cost recovery system (ACRS) On August 13, 1981, President Reagan signed into law the Economic Recovery Tax Act ( ERTA ) of 1981, which provided for ACRS. ACRS was based on a recovery period, instead of useful life under the then-elective Class Life Asset Depreciation Range System (ADR). Modified Accelerated cost recovery system (MACRS) With the Tax Reform At of 1986, Congress modified ACRS; MACRS allows for a somewhat lesser accelerated rate of recovery than ACRS. 11

12 Bonus Depreciation On March 9, 2002, President Bush signed the Job Creation and Worker Assistance Act of Immediate federal tax deduction of up to 30 percent. Acquired on or after September 11, The law applied to tax years ending after September 10, Jobs and Growth Tax Relief Reconciliation Act of 2003 Increased federal bonus depreciation amount to 50% (from 30%) Applied to property which is acquired by the taxpayer after May 5, 2003, and before January 1, On February 13, 2008, Economic Stimulus Act of 2008 That law provided for a 50% bonus depreciation for property acquired during the 2008 calendar year. 12

13 Bonus Depreciation On February 17, 2009, President Obama signed into law H.R. 1, the American Recovery and Reinvestment Act of 2009 (P.L ). The law extends through 2009 the bonus depreciation provision included in the 2008 stimulus package. 13

14 Depreciation Compliance Maintaining state depreciation schedules, in addition to: Federal tax depreciation schedules; AMT depreciation schedules; and Financial accounting depreciation schedules Disposition of assets: Gain/loss amounts will vary from federal gain/loss amounts because of different tax basis at the federal/state level. 14

15 IRC 179 Section 179 provides for an election to expense certain depreciable business assets : The expense amount was increased from $25,000 to $125, American Recovery & Reinvestment Act Hiring Incentives to Restore Employment Act: Deduction increased to $250,000 for 2009 & 2010 Phase-out: if cost of section 179 property placed in service during such taxable year exceeds $200,000 (or $500,000 in the case of taxable years beginning after 2006 and before 2011) (or $800,000 with 2009 law change). More than 10 states have decoupled from Section

16 IRC 199 The American Jobs Creation Act of Section 199 provides for a deduction equal to: 3% - tax years beginning in 2005 & % - tax years beginning in 2007, 2008, & % - tax years beginning after 2009 Of the lesser of: The qualified production activities income of the taxpayer for the taxable year, or Taxable income (determined without regard to Section 199) for the taxable year. About 20 states have indicated that they will not conform to Section

17 Net Operating Losses IRC Section 172: NOLs arising in tax years beginning before August 6, 1997 Carried back three years; or Forward 15 years. NOLs derived from tax years beginning after August 5, 1997 Carried back two years; or Carried forward 20 years. NOLs generated in tax years that end in 2001 and 2002 The carryback is five years. 17

18 Net Operating Losses 2/17/2009: American Recovery and Reinvestment Act 5 year carryback for 2008 NOLs, But, applies to small businesses only 11/6/2009: Worker, Homeownership, and Business Assistance Act 5 year carryback for 2008 & 2009 All businesses (except TARP) 18

19 States Deviations from Federal NOL Rules The carry-back period may differ; Prohibited from carrying back the NOL; The carry-forward period may differ; Cap on NOL carry-back; Cap on NOL carry-forward; Cap on NOL deduction in a tax year. 19

20 States Deviations from Federal NOL Rules Post-apportioned NOLs; Limitation on utilizing NOLs generated in a year when the taxpayer was not conducting business in the state; Existence of state NOL may depend on existence of a Federal NOL; Some states allow pre-apportioned NOLs to only offset Federal Taxable Income (the starting point); or Separate entity NOLs when filing consolidated or unitary/combined tax returns. 20

21 Section 385 Debt Equity Regulations Major impact of regulations: Creates a general operating rule under which the Internal Revenue Service ( IRS ) (but not taxpayers) may treat certain related-party debt instruments partially as debt and partially as stock, based on the substance of those instruments under general federal tax principles (Prop. Treas. Reg ) Certain related-party debt instruments will automatically be re-characterized as stock unless specific contemporaneous documentation and information requirements are met (Prop. Treas. Reg ) Certain related-party debt instruments will automatically be treated as stock if issued as part of specific related-party transactions ( Tainted Transactions ) or if an entity borrows from a related party 36 months before or after engaging in a Tainted Transaction (Prop. Treas. Reg and -4) 21

22 Section 385 Debt-Equity Regulations Prop. Treas. Reg (e) specifically provides: Treatment of consolidated groups. For purposes of the regulations under section 385, all members of a consolidated group (as defined in (h)) are treated as one corporation. Known as the consolidated group exception or the single entity rule State income tax impact: Will the states conform to the proposed regulations and/or the consolidated group exception? Will the states have powers independent of the IRS to police these rules? Can states make debt-equity determinations that are different than those made by the IRS? What effect will the Section 385 Regulations have on the interest expense provisions of existing state add-back statutes? 22

23 Consolidated Return Regulations Deviations 23

24 Basis Issues 24

25 Basis Issues When states do not conform to the federal consolidated return regulations taxpayers must separately track state and federal basis in property Outside Basis (parent s basis in subsidiary s stock) Inside Basis (subsidiary s basis in its assets) 25

26 Basis Issues Outside Basis: Separate reporting states may not adjust a parent s outside basis in subsidiary stock Treas. Reg : a parent receives basis adjustments to its basis in a subsidiary s stock for the subsidiary s income or losses Reduces/eliminates multiple taxation within consolidated group Separate reporting states may not permit similar adjustments to parents basis in subsidiary stock 26

27 Basis Issues Outside Basis Example: Parent and subsidiary file a federal consolidated return. Parent sells subsidiary s stock. Federal: the parent s gain is partially or entirely reduced per the federal consolidate return regulations basis adjustments. State: the parent may recognize gain or loss measured by its original basis (unadjusted by consolidated return regulations) See, e.g., Appeal of Rapid American Corp., 96-SBE-019A-0284 (Cal. Bd. Equal. May 8, 1997) 27

28 Basis Issues Inside Basis: Separate reporting states will not change a subsidiary s basis in its assets ( inside basis ) Pursuant to IRC 108, corporation does not recognize cancellation-of-debt income ( CODI ), but instead reduces tax attributes, including basis in property Pursuant to Treas. Reg , parent looks through subsidiary to the subsidiary s assets, causing the subsidiary to reduce inside basis. States decoupling from federal depreciation rules. 28

29 Basis Issues Inside Basis Example: Parent and subsidiary are part of the same federal consolidated group. Parent is insolvent, declares bankruptcy and debt is cancelled. Pursuant to IRC 108, parent does not recognize cancellation of debtincome, but reduces tax attributes, including basis in property Pursuant to Treas. Reg , parent looks through subsidiary, causing subsidiary to reduce basis in its assets Separate reporting states generally will not reduce subsidiary attributes based on parent non-recognition under IRC 108 But see MCI Comm. Servs. v. N.J. Dir., Div. of Taxation, N.J. Tax Court Dkt (July 20, 2015) 29

30 Deferred Recognition Treatment 30

31 Deferred Recognition Separate Reporting States: Non-Conformity to the federal consolidated return regulations Combined or Consolidated Reporting States: Full Conformity to consolidated return regulations Partial Conformity to consolidated return regulations Non-Conformity to the consolidated return regulations 31

32 Deferred Recognition Separate Reporting States Non-Conformity Entities under common ownership remain separate taxpayers Other separate reporting provisions may apply to alter or defer recognition e.g., IRC 482, 267(b) Certain separate reporting states have discretionary authority to combine or consolidate related taxpayers See: N.J. Stat. Ann. 54:10A-10(c) 32

33 Deferred Recognition Combined Reporting States 3 types Full Conformity States (e.g., NY, CO) Defers recognition consistent with Treas. Reg Partial Conformity States (e.g., CA) California mostly conforms to Treas. Reg , but otherwise does not conform to FCRR (e.g., Treas. Reg basis adjustments); see Appeal of Rapid American Corp., supra Non-Conformity States (e.g. TX, UT) Require each entity to calculate income on separate company basis Eliminate gains or losses on intercompany transactions May not follow FCRR basis rules for determining basis of property in parties hands following transaction 33

34 Deferred Recognition Interplay between basis and deferral regimes Federal excess loss accounts ( ELAs ) Parent s reduction to basis in subsidiary stock can create negative basis Parent does not realize gain until ELA is triggered by selling or liquidating stock California Deferred Intercompany Stock Accounts ( DISAs ) California law deviates from ELA treatment 34

35 Deferred Recognition Combined or Consolidated Reporting States Caveat: Taxpayers filing in states that have combined or consolidated reporting may still have group composition issues.e.g., Virginia (only companies with separate company nexus included in return) 35

36 Group Composition 36

37 Group Composition Composition of a Group Return Can Significantly Alter the Tax Treatment and Impact Tax Liability of the Group Types of Federal Returns: Separate Returns Consolidated Return Types of State Returns: Unitary Combined Return State Consolidated Return (same as or different than federal composition) State Hybrid Combined/Consolidated Return Selective Combined Return Separate Company Return 37

38 Group Composition States that conform to the consolidated return regulations still may not conform when both entities are not in the same return. Full and partial conformity states may thus default to separate company treatment. 38

39 Group Composition Reasons for disconnect between federal and state groups Constitutional limitations The U.S. Constitution prohibits states from including certain entities (i.e., non-unitary entities). No similar limitation for federal consolidated groups (consolidated return regulations do not require unitary relationship). States may also include entities that do not meet federal consolidated return ownership threshold Federal: 80% vote and value; States: 80% vote or value; 50%+ vote or value 39

40 Group Composition Other factors determining composition: States that include entities in combined group based on separate entity nexus determinations e.g., Virginia States that have combined/consolidated reporting that do not require unitary relationship. Taxpayer may choose to file combined even if not constitutionally permissible for state to require combined reporting e.g., Colorado, New York (old law) 40

41 Loss Limitations 41

42 Loss Limitations Federal Consolidation and SRLY Rules A federal consolidated group computes its net operating loss on a group basis. However, federal consolidation principles limit the use of NOLs by the consolidated group when generated by a member in a separate return year. 42

43 Loss Limitations SRLY Requirements If a NOL in a separate return year arose in a year when the corporation could have joined in a consolidated return, then the group can use the loss. If the loss arose during a year in which the corporation was not a member of the affiliated group, then: Use of NOLs generated by a member in a separate return year limited to the extent of that member s taxable income in the group in the carryover year; Cannot use loss to offset income of other members. 43

44 Loss Limitations State Conformity Some, but not all, states follow federal consolidation principles (e.g. 1502) e.g. Alabama follows federal SRLY rules (Ala. Code ) Computation performed at the unitary group or separate member level Illinois NOL computation follows group theory California NOL computation follows separate company theory 44

45 Loss Limitations Coca-Cola Enterprises Inc. v. Ala. Dep t of Revenue, No. Corp (Ala. Dep t of Rev. Feb.14, 2013) Alabama ALJ held that an affiliated group can deduct NOLs from years when the group did not file an Alabama consolidated return. Corporation that incurred the loss must have been a member of the group at the time the loss arose. Group must meet definition of affiliated group at the time the loss arose Thus, an affiliated group can exist before it elects to file an Alabama consolidated return 45

46 QUESTIONS 46

47 Thank You Jordan M. Goodman Marilyn A. Wethekam Horwood Marcus & Berk, Chartered 500 W. Madison St., Suite 3700 Chicago Illinois