Global Intangible Low Taxed Income
The Tax Cuts and Jobs Act (TCJA) moved business taxes from a “worldwide” system to a “quasi-territorial” system. The new system is closer to the global norm, under which businesses are taxed only on domestic income. In other words, under the TCJA, businesses are taxed principally on the income they earn in the U.S. The new system does include some elements of taxation of foreign income (hence it is quasi-territorial rather than truly territorial), including Global Intangible Low-Taxed Income (GILTI).
Under the prior federal tax system, states generally did not include foreign income in their own tax bases, for both policy reasons and Constitutional limitations. States should continue to respect these policy and Constitutional rationales and avoid taxation of foreign income by excluding GILTI from the state business tax base.
In 2018, many states focused on the transition tax on repatriated income and did not address GILTI. Nevertheless, 21 states have either decoupled from GILTI or exclude 95 percent of GILTI from the state tax base. In another 14 states, the state has a deduction that may apply to GILTI, or the deduction for GILTI is less than 95 percent. Only six states tax 50 percent or more of GILTI.
Interest Expense Limitations
Eight of the 21 states that took federal tax reform implementation action decoupled from the federal interest expense limitation, as recommended by the STAR Partnership. The federal provision provides no material benefit to states and would be extremely complex to impose, administer, and comply with at the state level.
Repatriation Transition Tax
Decoupling from federal tax reform’s Repatriation Transition Tax (RTT) provisions has been the norm for states. The STAR Partnership recommends that states decouple from federal provisions addressing repatriated foreign earnings in order to remain consistent with policies to avoid taxation of foreign income, and a significant majority of states followed this recommendation. Under the prior federal tax system, states generally did not include foreign income in their own tax bases, for both policy reasons and Constitutional limitations. States should continue to respect these policy and Constitutional rationales and avoid taxation of foreign income by excluding these provisions from their business tax bases.
A significant majority of states have decoupled from the one-time tax on repatriated earnings and profits. Twenty-six states have decoupled from the RTT. Only five states failed to decouple (or provide significant relief) and thus include one-time repatriated foreign earnings and profits in their state tax bases.
Foreign Derived Intangible Income
The Tax Cuts and Jobs Act (TCJA) includes a new deduction to remove disincentives for businesses that own and maintain intellectual property in the United States and use that property worldwide. This new code section—IRC section 250(a)(1)(A)—is referred to as Foreign-Derived Intangible Income (“FDII”). Maintaining intellectual property within the United States and employing it worldwide fosters investment and supports highly compensated, career-oriented jobs. State conformity to FDII supports this important national policy goal.
Twenty-seven of the 44 states with a corporate income tax likely allow the FDII deduction through their conformity with the federal Internal Revenue Code. Only 11 states and D.C. do not allow this deduction.
Other Key Priorities
The STAR partnership has also issued recommendations on the following additional issues:
Contributions to Capital
Six of the 21 states that took federal conformity action followed the STAR Partnership’s recommendation to decouple from section 118 provisions on contributions to capital. This federal provision would specifically contravene state policy goals by imposing taxes on states’ own economic development incentives. The remaining 15 states did not decouple from section 118 provisions and instead conformed to them, thereby including certain economic development incentives in their state tax base.
Four of the 21 states that took conformity action followed STAR’s recommendation to decouple from federal FDIC fee provisions. This federal provision disallows a deduction for FDIC fees and was included in the TCJA purely as a means of raising revenue to offset other provisions that reduced federal business taxes. There is no similar state business tax reduction, and thus there is no rationale for states to limit the deductibility of FDIC fees. The remaining 17 states did not decouple from FDIC fee provisions and instead conformed to them, thereby including FDIC fees in the state tax base.
Four of the 21 states that took conformity action followed STAR’s recommendation to conform to federal expensing provisions (Oregon, South Carolina, Utah, and West Virginia). These federal code sections support investment in the U.S., and conforming supports this important policy goal. The remaining 17 states did not conform to federal expensing provisions and retained their existing (sub-optimal) depreciation schedules.