Impact of Federal Reform on State Corporate Income Tax Base & the Best and Worst of Sales Tax Administration Focus on New Mexico

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1 Council On State Taxation th Annual NMTRI Tax Policy Conference Impact of Federal Reform on State Corporate Income Tax Base & the Best and Worst of Sales Tax Administration Focus on New Mexico Nikki Dobay Senior Tax Counsel (COST)

2 Agenda Impact of Federal Tax Reform on the State Corporate Income Tax Base Overview and Fiscal Impact of the Tax Cuts and Jobs Act State Conformity and Non-Conformity Overview Key TCJA Provisions and the State Tax Impact The Best and Worst of Sales Tax Administration 2

3 3 Overview and Fiscal Impact of the Tax Cuts and Jobs Act

4 Key Tax Law Changes in the TCJA Lower Tax Rates Reduces individual and corporate income tax rates (40% rate cut) New 20% deduction for certain pass-through entity income Base Broadening Lower rates are offset significantly by a wide range of individual and business taxation base broadeners Examples: broad limitations on the deductibility of interest deductions and $10k limitation on state and local tax deductions for individuals International Tax Reform Moves the U.S. from a worldwide to a quasi-territorial tax system consistent with U.S. trading partners One-time transition tax on previously untaxed accumulated foreign earnings New foreign source tax provisions intended to raise revenues (to offset tax cuts) and tilt the playing field to favor domestic commerce over foreign commerce 4

5 Differential Federal and State Fiscal Impacts of TCJA According to the Joint Committee on Taxation, at the federal level, TCJA will result in about $6 trillion in tax cuts offset by about $4.5 trillion in revenue raisers over the first 10 years Individual tax cuts over 10 years: $1.127 trillion (most sunset on 12/31/25) Corporate tax cuts over 10 years: $329.4 billion (10% decrease in corporate tax base) Conversely, at the state level, TCJA will likely result in an increase of approximately 12% in the corporate tax base Generally states do not conform to the federal provisions that lower revenue (e.g., tax rate cuts), but do conform to many federal provisions that increase revenue (e.g., base-broadening measures) 5

6 Quantifying the impacts of TCJA on state corporate taxes New EY/COST/STRI study provides estimates of the impacts of TCJA on state corporate tax bases. Study examines the impact of all states updating their corporate tax codes to the TCJA, but remaining coupled to specific provisions as they have in the past. The estimated percentage change in the state corporate tax base from TCJA is about 12 percent over the first 10 years ( ), with significant variation among the states. 6

7 Estimated percentage change in state corporate tax base from TCJA, by state ( ) State % increase in state corporate tax base State % increase in state corporate tax base Alabama 11% Nebraska 11% Alaska* 12% Nevada n/a Arizona 14% New Hampshire* 13% Arkansas 12% New Jersey* 12% California** 12% New Mexico* 11% Colorado 12% New York* 12% Connecticut* 12% North Carolina 12% Delaware 10% North Dakota 10% Florida 13% Ohio n/a Georgia 12% Oklahoma 13% Hawaii* 13% Oregon* 10% Idaho 9% Pennsylvania* 14% Illinois 9% Rhode Island* 11% Indiana* 12% South Carolina 12% Iowa 13% South Dakota n/a Kansas 11% Tennessee* 12% Kentucky* 12% Texas n/a Louisiana 12% Utah* 12% Maine 12% Vermont 14% Maryland* 12% Virginia 13% Massachusetts* 12% Washington n/a Michigan 9% West Virginia 9% Minnesota* 12% Wisconsin* 9% Mississippi* 4% Wyoming n/a Missouri 11% District of Columbia 12% Montana* 9% Overall Change 12% * State starts with Form 1120 line 28. To the extent IRC Section 250 deductions not allowed, this impact would be higher by 4.5%. ** There may be a California impact relating to cash repatriation for waters -edge filers once the deemed repatriated earnings have been actually distributed as dividends to U.S. corporate shareholders. California has estimated this amount at approximately $350 million. 7

8 8 State Conformity and Non- Conformity Overview

9 State income tax conformity to IRC As of March 6, 2018 WA Key Fixed Rolling Selective No income tax CA OR NV ID UT MT WY CO ND SD NE KS MN IA MO WI IL MI OH IN KY WV PA VA NY ME VT NH MA CT RI NJ DE AZ NM OK AR TN NC SC DC AK TX LA MS AL GA MD HI FL Note MI IRC conformity is January 2012 or if elected by Taxpayer Current Year (i.e. Rolling) Note - CA & MA personal income tax law differs in its conformity to the IRC compared to CA & MA corporate tax law. Note - OH doesn t have a corporate income tax. Personal income tax IRC adoption is Fixed 9

10 Potential State Impact of Business Tax Reform Provisions Federal States Corporate tax rate reductions Special pass through entity deduction Limitation of net interest deductions that exceed 30% of adjusted taxable income Fully expensed investments Broadened tax base including repeal of Sec. 199 domestic production deduction States have own rates Potentially impacts minority of states tied to federal taxable income for PIT purposes Mostly state conformity (uncertain application to state filing groups) 2/3 of states opted out of bonus depreciation State conformity (although many states already opted out of the domestic production deduction) Limit NOL deductions Amortization of research and experimental expenditures Most states have their own NOL provisions Likely state conformity 10

11 Potential State Impact of International Tax Reform Provisions Federal 100 percent dividends-received deduction (DRD) Transition tax on deemed repatriated earnings States Most states have their own DRDs One-third of states tax some portion of Subpart F income and/or foreign dividends. Tax on global intangible low-taxed income (GILTI) earned by foreign subsidiaries Deduction of 50 percent of GILTI income Reduced tax on foreign-derived intangible income (FDII) of U.S. corporation Base erosion anti-avoidance tax (BEAT) Longer amortization schedule for foreign research and experimentation (15 years) Mostly state conformity (but constitutional limitations) Mostly state conformity (but special deduction linkage issues) Mostly state conformity (but special deduction linkage issues) Separate tax not in federal taxable income Likely state conformity (but constitutional issues) 11

12 Top Increases and Decreases in Federal Corporate Tax Base with TCJA and Potential State Conformity Business Tax Provision One-time transition tax on unrepatriated foreign earnings % Change in Federal Corporate Tax Base + 9 % State Conformity Modest conformity (but typically of 25% or less) Net interest expense limitation (30% of ATI) + 6.4% Mostly conformity Global intangible low-taxed income (GILTI) % (gross amount) Mostly Conformity Modification of net operating loss deduction + 5.3% Mostly non-conformity Base Erosion and Anti-Abuse Tax (BEAT) + 4.0% Non-conformity Amortization of research and experimental expenditures + 2.9% Mostly Conformity Repeal of domestic production activities deduction + 1.9% Mostly conformity Foreign derived intangible income (FoDII) deduction - 1.7% Mostly conformity Expensing provided under Section 168(k) bonus depreciation - 1.8% Modest conformity Global intangible low-taxed income (GILTI) deduction - 2.6% Mostly conformity 100% foreign DRD - 5.9% Mostly conformity 12

13 Key TCJA Provisions and the State Tax Impact

14 State Income Starting Point Line 30 Line 28 WA Gross receipts tax or no corporate income tax Other MT ND ME OR ID WY SD MN WI MI NY VT NH MA CT CA NV UT CO NE KS IA MO IL IN KY OH WV PA MD VA NJ DE DC RI AZ NM OK AR TN SC NC AK HI TX LA MS AL GA FL Source: COST/STRI/EY study 14 This analysis assumes each state will update to the 2018 IRC consistent with the provisions the state conformed to prior to the enactment of the TCJA. This map is intended for general information purposes only and should not be relied upon for tax advice.

15 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 Reported on return of U.S. shareholders for the last taxable year of the foreign corporation beginning before January 1, 2018, but taxpayers are able to elect to pay any resulting liability over an eightyear period. IR (March 13, 2018): Transition tax base is reportable on a separate IRC 965 Transition Tax Statement. Resultant tax liability reported on line 31 of Page 1 of Form 1120 (Total tax). 15

16 Potential State Taxation of Accumulated Foreign Earnings WA Assumes no impact Assumes partial or full impact California special treatment MT ND ME OR ID WY SD MN WI MI NY VT NH MA CT CA NV UT CO NE KS IA MO IL IN KY OH WV PA MD VA NJ DE DC RI AZ NM OK AR TN SC NC AK HI TX LA MS AL GA FL Source: COST/STRI/EY study 16 This analysis assumes each state will update to the 2018 IRC consistent with the provisions the state conformed to prior to the enactment of the TCJA. This map is intended for general information purposes only and should not be relied upon for tax advice.

17 Transition Tax: SALT Implications Impact is largely based on: States starting point for calculation of state taxable income: the transition tax is reported and calculated on a separate IRC 965 Transition Tax Statement, with the liability going into line 31 and line 32 of Form State treatment of subpart F income State adoption of IRC 965 (c) (effectively providing reduced tax rates) Taxpayers state income tax filing method worldwide combined, water s-edge, or separate 17

18 Transition Tax: SALT Implications Timing States traditionally do not afford a similar payment deferral mechanism as allowed for federal income tax purposes Conforming states may run afoul of Kraft Factor representation - Is the inclusion of foreign (deemed) dividends, but not including the corresponding apportionment factors of the specified foreign corporations unconstitutionally discriminatory? 18

19 GILTI: IRC 951A and 250 Imposes tax on a U.S. taxpayer s GILTI: CFC income in excess of a proxy for routine returns (e.g. in excess of 10% rate of return) 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 (13.125% after 2025) GILTI is specifically not considered Subpart F income for Federal purposes except where IRC 951A otherwise says it is Foreign tax credits ( FTCs ) are permitted for 80% of the foreign taxes paid with respect to such income, assuming average foreign tax rate imposed on such income is at least % 19

20 Potential Taxation of GILTI Income (Inclusion) No exclusion of income Excludes income WA Gross receipts tax States that have delinked from GILTI MT ND ME OR ID WY SD MN WI MI NY VT NH MA CT CA NV UT CO NE KS IA MO IL IN KY OH WV PA MD VA NJ DE DC RI AZ NM OK AR TN SC NC AK HI TX LA MS AL GA FL Source: COST/STRI/EY study 20 This analysis assumes each state will update to the 2018 IRC consistent with the provisions the state conformed to prior to the enactment of the TCJA. This map is intended for general information purposes only and should not be relied upon for tax advice.

21 GILTI: SALT Implications Potential base broadening Because IRC 951A is a new section, states will generally not have a specific exclusion for GILTI If IRC 250 is considered a special deduction, 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 vs. line 30 income after NOLs and special deductions Splitting of IRC 951A and IRC 250 providing for inclusion without deduction 21

22 GILTI: SALT Implications Disconnect from federal treatment, as states generally do not permit use of FTCs The impact of GILTI will be affected by a taxpayer s state income tax filing method Kraft issues Factor representation Is the inclusion of foreign (deemed) dividends, but not including the corresponding apportionment factors of the CFCs unconstitutionally discriminatory? 22

23 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 %, subject to a taxable income limitation ( % after 2025) FDII is calculated in a manner similar to GILTI. Returns in excess of 10% of fixed assets form the basis for the calculation 23

24 FDII: SALT Implications Deduction for FDII under IRC 250 is likely 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 24

25 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. 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. 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. 25

26 BEAT: 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 26

27 Interest Expense Limitation IRC 163(j) General Overview: Business interest expense cannot exceed 30% of FTI exclusive of business interest income, business interest expense, depreciation, amortization. State Tax Issues: How is the limitation computed for state purposes when the state and federal filing methodologies differ? External vs. internal debt? Will state allow indefinite carryforward of disallowed interest expense? How will the federal limits interact with state related party interest expense disallowance statutes? 27

28 100% Bonus Depreciation IRC 168(k) General Overview: 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, The 100% expensing is phased down by 20 percentage points per calendar year beginning in State Tax Issues: Will states conform? In state that historically decoupled from bonus, will they decouple from the increase to 100%? Straight coupling to federal vs. MACRS vs. different approaches Having to track different methods in different states 28

29 COST Conformity Principles Manage conformity to achieve revenue neutrality and avoid increasing the state s business tax burden Do not selectively conform to revenue-increasing federal tax reform changes only Example: GILTI but not IRC Section 250 deduction. Example: Interest deduction limitation but not 100% expensing Do not conform to new foreign source income provisions that would expand the state tax base beyond the water s edge Examples: GILTI; BEAT States should provide guidance to facilitate state income tax compliance with complex new federal tax reform provisions. 29

30 State Conformity Changes: Base Narrowing Legislation as of mid-april 2018 Corporate Rate Cuts Following Federal Tax Reform FL (H.B. 7093); GA (H.B. 918); ID (H.B. 463) General Decoupling from TCJA Base Broadeners WI (A.B. 259) decoupled from Interest Expense Limit, GILTI, FDII, R & E amortization, Full Expensing, BEAT, Repatriation Decoupling from Interest Expense Limitation GA (H.B. 918); MS (no conformity due to preexisting law) Tenn. (in 2020) Decoupling from GILTI GA (S.B. 328); IL, MI, MT, WI (no conformity due to preexisting law) Allowing GILTI Deductions NY (DTF statement that IRC 250 deductions included; FDII decoupled in budget) Transition Tax Installment Payments UT (S.B. 244)

31 Best and Worst of Sales Tax Administration

32 Background on COST s Scorecards Purpose of Scorecards is to grade the state tax administration on an objective basis and to work with the states policy makers both executive and legislative to improve state and local tax administration for multijurisdictional businesses Other COST Scorecards: State Administrative Scorecard increase in independent tribunals & appeal period from 30 to 60 days Unclaimed Property Scorecard increase in states exempting gift cards and business-to-business transactions Property Tax Administration Scorecard International and improvement of some states appeal processes 32

33 The Sales Tax Scorecard Categories Exemption for Business-to-Business Transactions Fair Sales Tax Administration Centralized Sales Tax Administration Simplification & Transparency Reasonable Tax Payment Administration Fair Audit/Refund Procedures Other Issues Impacting Fair Tax Administration What the Scorecard Does Not Grade Tax Rate Differences Tax Base Breadth (other than Taxing Business Inputs) 33

34 Sales Taxes Make Up of Overall Business State and Local Taxes 6 6% 9% 8% 38% 2% 7% 4% 16% 20% 12% 11% 21% 42% United States New Mexico Taxes on business property Sales tax on business inputs Excise, utility & Insurance taxes Corporate income tax Business license, severance & other taxes Unemployment insurance tax Individual income tax on business income Source: COST, STRI, Ernst & Young: Total State and Local Business Taxes: State-by-State Estimates for Fiscal Year

35 States Overall Grades N/A N/A A B C D F WA MT ND ME CA OR NV ID UT WY CO SD NE KS MN IA MO WI IL IN MI KY OH WV NY PA MD VA VT NH MA CT NJ DE DC RI AZ NM OK AR TN NC SC AK HI TX LA MS AL GA FL 35

36 Exemption for Business-to-Business Transactions COST/EY Study highlighting overall tax on business inputs 2 points Manufacturing exemption 3 points Manufacturing equipment exemption 2 points Manufacturing inputs exemption 1 point Pyramiding tax of service industries 3 points Double tax on equipment to provide service and tax on service when sold to consumer New Mexico s Score 8 (out of 8) points 36

37 Exemption for Business Inputs States Grades WA N/A 0-1 pts 2 pts 3-4 pts 5-6 pts 7-8 pts N/A A B C D F MT ND ME CA OR NV ID UT WY CO SD NE KS MN IA MO WI IL IN MI KY OH WV PA MD VA NY VT NH MA CT NJ DE DC RI AZ NM OK AR TN NC SC AK HI TX LA MS AL GA FL 37

38 State and Local Sales Taxes Imposed on Business Inputs over Business Inputs Share of Total Sales Tax Collected 39% 37% 46% N/A 32% 33% 37% 58% 60% N/A 42% 25% - 35% 36% - 45% 46% + States With No Sales Tax 48% 58% 44% 41% 47% 46% 47% 39% 37% VT MA RI 51% 48% 36% 42% 42% N/A 32% 36% NJ MD DC 43% 42% 42% 42% 40% 37% 32% 44% 40% 43% 40% 37% 41% 35% CT 39% 52% 41% 36% 35% 44% N/A 42% HI 36% 38

39 Breadth of States Manufacturing Equipment Exemptions None or Restricted Exemption Direct or Primary Use Exemption Integrated Plant Exemption WA States with No Sales Tax CA OR NV ID AZ UT MT WY CO NM ND SD NE KS OK MN IA MO AR WI IL ME VT NH VT MA RI NY MA 32% MI CT NJ MD DC PA IN OH MD NJ KY WV VA TN NC SC CT TX LA MS AL GA AK FL HI 39

40 Double Taxation of Select Service Providers: Wired/Wireless, Cable, Electric and Gas 1 Service Industry Double Taxed 2 Service Industries Double Taxed 3 Service Industries Double Taxed No Double Tax States with No Sales Tax WA CA OR NV ID UT MT WY CO ND SD NE KS MN IA MO WI IL ME VT MA VT NH 32% MI NY MA CT NJ MD DC PA OH MD IN NJ WV VA RI CT AZ NM OK AR TN SC NC TX LA MS AL GA AK FL HI 40

41 Fair Sales Tax Administration Exemption Certificate Procedure - 2 points Good faith on acceptance 120-day period on audit to perfect Allow MTC or SSUTA certificate Verification of exemption/account number Vendor Compensation 2 points No vendor comp. or less than $12,000 per year (de minimis) - 2 points At least 0.5% for one-rate state or 0.75% for states with local rates no points Broad Direct Pay 1 point Not overly restrictive no thresholds over $1 million per year New Mexico s Score 5 (out of 5) points 41

42 Fair Sales Tax Administration States Grades 42

43 Good Faith Requirement 43

44 Exemption Certificates 44

45 Vendor Compensation 45

46 Direct Pay 46

47 Centralized Sales Tax Administration Population of state as compared to number of local jurisdictions - 1 point Less than 20,000 1 point Central administration 3 points Uniform tax base Centralized filing and auditing Centralized appeals Website has current & historical tax rates and boundaries 1 point New Mexico s Score 2 (out of 4) points 47

48 Centralized Sales Tax Administration States Grades 48

49 States with Local Sales Tax Jurisdictions 49

50 Number of Taxing Jurisdictions 50

51 Website with Boundary Database and Rates 51

52 Simplification & Transparency SSUTA State - 2 points Tax on digital products and prewritten software 2 points Is by legislation or administrative rule/policy position? Liability relief 1 point Relief should broadly apply to most written correspondence New Mexico s Score 4 (out of 5) points 52

53 Simplification & Transparency States Grades 53

54 Streamlined Sales Tax States 54

55 Taxation of Digital Goods 55

56 Taxation of a Person Merely Accessing Pre- Written Software No Tax Imposed Tax Imposed Without Statutory Authority Tax Imposed by Statutory Authority States With No Sales Tax WA MT ND ME CA OR NV ID UT WY CO SD NE KS MN IA MO WI IL IN MI KY OH WV NY PA MD VA VT NH MA CT RI NJ DE DC AZ NM OK AR TN NC SC AK HI TX LA MS AL GA FL 56

57 Tax Liability Relief for Sellers Relying on Guidance 57

58 Reasonable Tax Payment Administration Advance Payments - 2 points One per year or month 1 point Two or more per month 2 points Full credit other states sales/use taxes 2 points Credit sales and use tax 1 point Credit other states state and local taxes 1 point Periodic leases tax based on each lease payment 2 points State accelerating or continuing tax on leases when property no longer in the state 1 point Credit for tax paid in other states on such leases- 1 point Bad debt deduction applies to third-party private label credit card 1 point New Mexico s Score 3 (out of 7) points 58

59 Reasonable Tax Payment Procedure States Grades 59

60 Advance Payments No Advance Payments 1 Advance Payment Per Month or Year More Than 1 Advance Payment Per Month WA States with no sales tax MT ND ME CA OR NV ID UT WY CO SD NE KS MN IA MO WI IL IN MI KY OH WV PA MD VA NY VT NH MA CT RI NJ DE DC AZ NM OK AR TN NC SC AK HI TX LA MS AL GA FL 60

61 Tax Credit Against Sales and Use Tax 61

62 Full Credit For Other States State & Local Sales and Use Taxes 62

63 Bad Debt Deduction 63

64 Fair Audit/Refund Procedures Purchasers ability to obtain refunds directly from the state - 1 point False claims act & class action suits 2 points Allow either 1 point each Contingent fee or private auditing 1 point Allow either 1 point New Mexico s Score 1 (out of 4) points 64

65 Fair Refund/Audit Procedures States Grades 65

66 False Claims Act 66

67 Accelerated Lease Payments (ALPs) *CA, CO, TN: Continues tax on certain lease payments using origin location CA* OR WA NV No ALPs, No Credit No ALPs With Credit MT ID WY UT CO* AZ NM ND SD NE KS OK ALPs and Continued Tax on Leases With Credit ALPs and Continued Tax on Leases With No Credit MN IA MO AR WI IL IN MI TN* KY OH WV SC PA VA NC NY VT NH MA CT NJ MD DE DC ME RI AK MS AL GA HI TX LA FL 67

68 Class Action Suits 68

69 Contingent Fee / Private Auditing 69

70 SSN and Other Issues SSN and/or Home Addresses Other Issues WA CA OR NV ID AZ UT MT WY CO NM ND SD NE KS OK MN IA MO AR WI IL MI IN KY TN OH PA MD WV VA NC SC ME VT NH NY MA CT RI NJ DE DC AK HI TX LA MS AL GA FL 70

71 Questions? Nikki Dobay (COST) Portland, OR