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TWIST - This Week in State Tax

Multistate: Inflation Reduction Act Has Few SALT Implications

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Welcome to TWIST for the week of August 22, 2022, featuring Sarah McGahan from the KPMG Washington National Tax state and local tax practice.

As summer comes to an end, it has been a bit slow for state tax developments. Most state legislative sessions have concluded at this point, and we likely won’t see a lot of state tax legislation until the 2023 sessions commence. However, federal tax legislation was recently enacted, so today we are going to talk about the state implications.

For state corporate income tax purposes, much time and attention over the last few years has been focused on state conformity to federal law changes. The changes included in the Tax Cuts and Jobs Act and the federal COVID-19 relief bills have added a layer of complexity to the state corporate income tax compliance process. So, it should be a welcome relief to state taxpayers that the recently enacted Inflation Reduction Act will not result in a lot of thorny conformity issues. In fact, most of the tax changes in the new law that apply to corporate taxpayers are of the type that do not have direct SALT implications because they do not affect the calculation of a corporation’s federal taxable income. Significantly, the law adopts a new corporate AMT that is based on 15% of adjusted financial statement income. The new corporate AMT appears to be similar to the corporate AMT repealed as part of the TCJA in that it is structured as a separate tax regime that is not tied to federal taxable income. Accordingly, absent legislative action, states will generally not conform to the new corporate AMT. There may be a few exceptions in the handful of states that currently impose an AMT or tie to the former federal corporate AMT. The new law also adopts a 1 percent excise tax on stock buybacks by certain publicly traded corporations. Again, this new excise tax is structured as a separate tax that is not tied to the computation of federal taxable income. Absent state action to adopt a similar tax, there are no direct state income tax implications associated with the imposition of the new excise tax, even in the states that have rolling conformity to the Code. Finally, the new law includes numerous new and expanded climate-related tax credits and incentives. Generally, states have their own credits and incentives regimes and do not tie to federal credits.

Multistate

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For state corporate income tax purposes, much time and attention over the last few years has been focused on state conformity to federal law changes. The changes included in the Tax Cuts and Jobs Act (TCJA) and the federal COVID-19 relief bills have added a layer of complexity to the state corporate income tax compliance process. So, it should be a welcome relief to state taxpayers that the recently enacted Inflation Reduction Act will not result in a lot of thorny conformity issues.

As background, nearly every state corporate and personal income tax conforms in some manner to the Code for purposes of computing the state tax base. This is commonly accomplished by requiring taxpayers to begin the computation of state taxable income with federal taxable income or federal adjusted gross income. Conformity between state and federal taxes simplifies compliance for taxpayers, and at the same time, reduces the administrative burdens facing state tax authorities. States generally conform to the Code in one of two ways. Rolling or current conformity states tie the state tax to the Code for the tax year in question, meaning they automatically adopt all changes to the Code as passed by Congress unless the state passes legislation to decouple from specific provisions. Static or fixed-date conformity states tie to the Code as of a specific date (e.g., December 31, 2021), meaning the state legislature must act to incorporate any subsequent federal changes into the state tax code. States are about evenly divided between rolling and static conformity. A small number of states, notably California, adopt selected Code provisions on a static basis, rather than using the blanket approach used by most states. Static conformity states generally update their conformity annually or at least regularly. The notable exception is California that currently ties to the Code as of January 1, 2015, and Texas, which currently conforms to the Code as of January 1, 2007.

Because states generally conform to the Code through use of federal taxable income or federal adjusted gross income as the starting point for computing state taxable income, not all changes to the Code directly affect state income tax liabilities. Most of the corporate tax changes in the new law are of the type that do not have direct SALT implications because they do not affect the calculation of a corporation’s federal taxable income.1 Significantly, the law adopts a new corporate AMT that is based on 15% of adjusted financial statement income. The new corporate AMT appears to be similar to the former corporate AMT in that it is structured as a separate tax regime that is not tied to federal taxable income. Accordingly, absent legislative action, states will generally not conform to the new corporate AMT.  States may, of course, always enact legislation to piggyback on the new federal corporate AMT.

Prior to the enactment of the TCJA, about eight states imposed an alternative minimum tax on corporations. At least two states (e.g., Iowa and Maine) repealed their corporate AMT after the enactment of the TCJA.  In a few states that continue to impose a corporate AMT, there may be a connection to the new law. For example, under Alaska Stat. § 43.20.021(f), the state AMT is 18 percent of the applicable federal alternative minimum tax provided for in 26 U.S.C. 55-59.  After the repeal of the former federal AMT, the Alaska statute was essentially inoperative with respect to an Alaska corporate AMT.  The new corporate AMT based on book income is set forth in IRC section 55. Alaska is a rolling conformity state and as such, it appears that Alaska may once again impose an AMT based on the federal amount.

The new law also adopts a 1 percent excise tax on stock buybacks by certain publicly traded corporations. Again, this new excise tax is structured as a separate tax that is not tied to the computation of federal taxable income. Absent state action to adopt a similar tax, there are no direct state income tax implications associated with the imposition of the new excise tax, even in the states that have rolling conformity to the Code.

Finally, the new law includes numerous new and expanded climate-related tax credits and incentives. Generally, states have their own credits and incentives regimes and do not tie to federal credits.  One significant exception is the federal R&D credit; a number of states allow a counterpart credit based largely on the contours of the federal credit. Also, there may be indirect implications as a result of the expanded and new federal credits. Under IRC section 280C, taxpayers are disallowed deductions for some credits when the expenses related to those deductions have been used to compute certain federal tax credits. Consequently, if a taxpayer takes a federal tax credit in lieu of deducting certain business expenses, that choice can impact the taxpayer’s federal taxable income and can then flow through to the states unless a state authorizes a deduction for expenses that could not be deducted in the computation of the taxpayer’s federal taxable income due to the taxpayer claiming a federal credit.

In sum, the changes in the Inflation Reduction Act are not likely to cause as much angst from a state conformity perspective as compared to the significant tax changes affecting the computation of federal taxable income in the TCJA and the COVID relief bills. 

Thank you for listening to TWIST and stay well!


1Note that for non-corporate taxpayers- the two-year extension of the IRC section 461(l) loss limitation rules will flow through to the states that conform to this Code section, assuming the state is a rolling conformity state or conforms to a version of the Code that includes the changes made in the new law.

Podcast host

Sarah McGahan

Sarah McGahan

Managing Director, State & Local Tax, KPMG US

+1 213-593-6769