Recent developments in Washington show that the future of tax legislation is murky to say the least. But, with certainty, we can say that 2017 promises to bring more action on, debate over, and interest in tax reform than we have seen since the Tax Reform Act of 1986.
The potential implications of federal tax reform have caught the attention of many U.S. companies. In addition to monitoring developing stories at the federal level, executives should not overlook the potential repercussions that Congress’ decisions could have on their state taxes.
The impact of federal tax reform is likely to be strongly reflected in state tax legislation, but not consistently across states. While nearly every state imposes a corporate income tax that conforms (in some way) to the federal corporate income tax, states often do not conform to various federal provisions, such as the Domestic Activities Production Deduction or bonus depreciation. In fact, states tend to “pick and choose” which provisions they follow, usually based on how they affect the state’s own tax revenue. Most states have their own array of credits and incentives, so do not adopt federal tax credits, such as those for alternative energy sources.
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Unlike the federal government, nearly every state is required to maintain a balanced budget, meaning they can’t borrow to cover operating expenses. Still, per the National Association of State Budget Officers, more than 30 states are currently facing budget shortfalls. With revenues generally expected to fall short of expenditures in certain states in the current fiscal year, states are likely to avoid any changes that might jeopardize expected tax revenue.
State tax rules vary widely, so any change in Washington will play out differently across states. And the impact of these potential changes will depend on the degree to which a state currently conforms to federal tax law. Companies may need to respond to this uncertainty with a different plan for every state where they pay taxes.
When and how any changes are implemented remains to be seen. There will likely be a time lag between federal and state reforms. Given that many state legislatures will have adjourned before any final action in Congress if tax reform is passed at the federal level in 2017, many states will likely not be able to respond until 2018. Some states may choose not to respond until a period of time after the federal reforms are effective so as to better gauge the potential impact on the state.
With all of this to consider, the outlook for state corporate taxes will be highly uncertain for the immediate future. Despite the murky waters, now is not a time to sit back and wait. Now is the time to analyze and prepare for managing the potential impact of federal tax reform on state taxes.
Here are some key steps to take to help anticipate the impact and plan accordingly.
Identify posture across states. Assess your situation in every state where you have significant tax liabilities. The analysis should include not only what’s driving your tax burden but the key characteristics of each state’s tax system.
Model local impact. Determine how any federal reforms might affect the tax base in those key states and how it might change your own tax liability. Create a model to assess how changes might alter your state tax position.
Anticipate state reaction. Watch what key officials in these states are saying about how federal reforms might affect taxes in their states. Their comments can provide insights into whether the state will change taxes in the same manner as Congress.
Measure fiscal outlook. Analyze the fiscal outlook of key states for the next two to four years which will hint at potential state reactions to federal reform.
Monitor state tax assets and liabilities. Assess how federal reforms might change the value of your deferred state tax assets and liabilities. You may have to alter your tax planning to address if the impact is significant.
Act now. Figure out what steps you can take now to mitigate any undesirable outcomes or to enhance the positives.
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