Carrying on our tradition of providing you with Solutions Beyond the Obvious, we are pleased to bring you our “Ask the Experts” series of articles. In these articles, our Tronconi Segarra & Associates tax experts identify and explain the significant tax changes that were passed as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act which can provide additional relief for businesses and individuals facing economic hardship as the result of the coronavirus pandemic. Contact your Tronconi Segarra & Associates tax advisor for more information about any of the topics discussed in these articles.
Robert H. Lamb, CPA
The computation of state corporate taxable income is highly dependent upon how federal corporate taxable income is computed. Whenever federal corporate income tax law changes are enacted, it is necessary to consider how the federal law changes will impact computation of state corporate taxable income. Determining how federal law changes will impact computation of state corporate taxable income depends upon how and when the various states conform to the Internal Revenue Code (“IRC”). State conformity typically relies upon the following methods:
- Rolling – CARES Act conformity is generally automatic (state automatically conforms to the IRC as enacted). Approximately half the states imposing corporate income tax utilize the Rolling conformity method. Illinois and New York are examples of Rolling conformity states.
- Fixed – CARES Act conformity is generally not automatic (state conforms to the IRC as of a specific date). Slightly less than half of the states imposing corporate income tax utilize the Fixed conformity method. Florida and Texas are examples of Fixed conformity states.
- Selective – CARES Act conformity generally depends (state may adopt only certain specific provisions of the IRC or have a unique approach to conformity). California and Pennsylvania are examples of Selective conformity states.
However, it should be noted that it is not unusual for states to decide to decouple from or modify certain specific IRC sections regardless of the conformity method utilized by the state, including states which use the Rolling conformity method.
The CARES Act was enacted March 27, 2020. At this point in time, the CARES Act provisions impacting federal taxable income will have the most impact on state taxable income for Rolling conformity states since Fixed and Selective conformity states may not yet have updated their specific date of IRC conformity to include the March 27, 2020 enactment date.
Significant CARES Act items impacting federal and state taxable income computations include the new 5-year Net Operating Loss (“NOL”) carry-back for losses incurred in tax years 2018 – 2020, the change to the IRC Section 163(j) limitation for determining deductible business interest expense, and the tax depreciation method change for Qualified Improvement Property (“QIP”).
- 5-Year NOL Carry-back – this federal change will have limited impact on state NOL deductions, even for Rolling Conformity states, since most states have their own NOL deduction rules which decouple from the federal NOL deduction rules. Importantly, most states no longer allow NOLs to be carried back at all. And the handful of states that allow carry-backs may not follow the federal carry-back periods. For example, New York, a Rolling conformity state, has its own separate 3-year NOL carry-back provision which came in with the New York tax reform legislation back in 2014. The New York NOL deduction rules do not follow the IRC Section 172 NOL deduction rules. Therefore, taxpayers will need to continue to separately keep track of available state NOL carryovers, which in most cases will be different from Federal NOL carryovers.
However, it should be noted that prior year state tax returns may need to be amended after federal NOL carry-backs due to ancillary changes in federal taxable income. For example, before the 2018 tax year, the IRC Section 199 domestic production activities deduction, to which some states conformed, was subject to a limitation based in part on federal taxable income after NOL and special deductions. Another example could be changes to the IRC Section 250 deductions for global intangible low-taxed income and foreign-derived intangible income, to which many states conform in whole or in part, since these deductions are impacted by the amount of the federal NOL deduction. So, even though the new federal 5-year NOL carry-back provision may have no impact on most state NOL deduction positions, there still may be a requirement to file prior year amended state returns if federal taxable income (excluding the impact of the federal NOL carry-back deduction) has changed. Prior year changes to federal taxable income used to compute state taxable income are always required to be reported to the states.
- Changes to IRC Section 163(j) Limitation – the CARES Act temporarily increases the federal adjusted taxable income (“ATI”) limitation from 30% to 50% for 2019 and 2020, and an election is provided to use 2019 ATI for the 2020 year limitation calculation. State impacts for this change will vary depending upon the IRC conformity method utilized (Rolling/Fixed/Selective), as well as due to specific state statutory modifications to IRC Section 163(j) which were made previously when Section 163(j) was enacted as part of the federal Tax Cuts and Jobs Act (“TCJA”) legislation back in 2017. Several states are still trying to determine how to apply the TCJA Section 163(j) limitation, particularly for combined /consolidated return filing states, so this change will create added confusion for taxpayers in attempting to compute the amount of allowable interest expense deduction for state tax purposes. Several states, including certain Rolling conformity states, have previously decoupled from or modified the IRC Section 163(j) limitation; and there undoubtedly will be more changes on the horizon as states get around to determining how or if they want to follow the new CARES Act IRC Section 163(j) limitation. For example, New York, a Rolling conformity state, has already partially decoupled by keeping the ATI limitation at 30% for 2019 and 2020, but appears to be allowing use of the 2019 ATI for the 2020 limitation calculation (see the 2020-2021 NYS Budget Bill). Stay tuned for further developments!
- Depreciation Method Change for QIP – the CARES Act makes a technical correction to the TCJA to provide that Qualified Improvement Property (“QIP”) placed in service on or after December 22, 2017 is depreciated over 15 years rather than 39 years. This correction also means that QIP is now eligible for 100% bonus depreciation for federal purposes. To the extent taxpayers change their depreciation method to claim 100% bonus on QIP for federal purposes, there likely will not be a significant impact on state taxable income since most states already decouple from federal bonus depreciation and require depreciation to be computed under an allowable federal method if bonus depreciation was not available. There may be some state depreciation benefit to the extent allowed to depreciate QIP over the corrected 15-year life as opposed to the former 30-year life.
Please contact your Tronconi Segarra & Associates tax advisor for more information on this or any tax matter. If you do not have a Tronconi Segarra & Associates tax advisor, please call 716.633.1373 or Contact Us through our website with your question.
This article has been prepared for general guidance on matters of interest only; it does not constitute professional advice. You should not act upon the information contained in this article without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy of completeness of the information contained in this article; and, to the extent permitted by law, Tronconi Segarra & Associates LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this article or for any decision based on it.