Upload
others
View
1
Download
0
Embed Size (px)
Citation preview
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
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
4
Why Non-Conformity?
• Revenue raising
• Administrability
• Economic stability
• Equality/horizontal equity
• Economic inequality/vertical equity
• Neutrality/free market
• Political order
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
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.
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
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.
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.
12
Bonus Depreciation
• On March 9, 2002, President Bush signed the Job Creation and Worker Assistance Act of 2002. – Immediate federal tax deduction of up to 30 percent.
– Acquired on or after September 11, 2001.
– The law applied to tax years ending after September 10, 2001.
• 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, 2005.
• 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.
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. 111-5).
• The law extends through 2009 the bonus
depreciation provision included in the 2008
stimulus package.
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.
15
IRC § 179
• Section 179 provides for an election to expense certain depreciable business assets.
– 2007-2010:
• The expense amount was increased from $25,000 to $125,000.
– 2009 American Recovery & Reinvestment Act.
– 2010 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 179
16
IRC § 199
• The American Jobs Creation Act of 2004.
– Section 199 provides for a deduction equal to:
• 3% - tax years beginning in 2005 & 2006
• 6% - tax years beginning in 2007, 2008, & 2009
• 9% - 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 199.
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.
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)
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.
20
States’ Deviations from Federal NOL Rules
• Post-apportioned NOLs;
• Limitation on utilizing NOLs generated in a year whenthe taxpayer was not conducting business in the state;
• Existence of state NOL may depend on existence of aFederal 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.
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. § 1.385-1)
– Certain related-party debt instruments will automatically be re-characterized as stock
unless specific contemporaneous documentation and information requirements are met
(Prop. Treas. Reg. § 1.385-2)
– 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. §§ 1.385-3 and -4)
22
Section 385 Debt-Equity Regulations
• Prop. Treas. Reg. § 1.385-1(e) specifically provides:
– “Treatment of consolidated groups. For purposes of the regulations under section 385, all members of
a consolidated group (as defined in §1.1502-1(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?
25
• 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)
Basis Issues
26
• Outside Basis: Separate reporting states may not adjust a parent’s outside
basis in subsidiary stock
– Treas. Reg. § 1.1502-32: 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
Basis Issues
27
• 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)
Basis Issues
28
• 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. § 1.1502-28, parent “looks
through” subsidiary to the subsidiary’s assets, causing the
subsidiary to reduce inside basis.
• States decoupling from federal depreciation rules.
Basis Issues
29
• 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 debt-
income, but reduces tax attributes, including basis in property
• Pursuant to Treas. Reg. § 1.1502-28, 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. 013905-2010 (July 20, 2015)
Basis Issues
31
• 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
Deferred Recognition
32
• 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)
Deferred Recognition
33
• Combined Reporting States – 3 types
– Full Conformity States (e.g., NY, CO)
• Defers recognition consistent with Treas. Reg. § 1.1502-13
– Partial Conformity States (e.g., CA)
• California mostly conforms to Treas. Reg. § 1.1502-13, but otherwise does not conform to FCRR (e.g., Treas. Reg. § 1.1502-32 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
Deferred Recognition
34
• 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
Deferred Recognition
35
• 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)
Deferred Recognition
37
• 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
Group Composition
38
• 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.
Group Composition
39
• 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
Group Composition
40
• 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)
Group Composition
42
• 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.
Loss Limitations
43
• 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.
Loss Limitations
44
• State Conformity
– Some, but not all, states follow federal consolidation principles (e.g. § 1502)
• e.g. Alabama follows federal SRLY rules (Ala. Code §40-18-39)
– Computation performed at the unitary group or separate member level
• Illinois – NOL computation follows group theory
• California – NOL computation follows separate company theory
Loss Limitations
45
• Coca-Cola Enterprises Inc. v. Ala. Dep’t of Revenue, No.
Corp. 09-641 (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
Loss Limitations
47
Thank You
Jordan M. Goodman
312-606-3225
Marilyn A. Wethekam
312-606-3240
Horwood Marcus & Berk, Chartered
500 W. Madison St. , Suite 3700
Chicago Illinois 60661