After more than 100 days of a new U.S. presidency, state and local officials remain uncertain of the direction of federal tax policy and how it will affect their current and future fiscal situation. Administration and congressional tax reform ideas such as implementing a “border-adjusted tax,” replacing depreciation with immediate expensing of fixed assets, eliminating alternative minimum tax and requiring the repatriation of foreign profit would have a dramatic impact on state income and franchise taxes. Rate adjustments might be required and states may have to seriously consider decoupling from the Internal Revenue Code (IRC).
For example, legal experts have raised questions about whether states could adopt a federal border-adjusted tax base. States have been barred by federal courts from discriminatory tax practices that places a heavier burden on income from foreign sources versus domestic sources. See Kraft Gen. Foods, Inc. v. Iowa Dep’t of Revenue & Fin., 505 U.S. 71, 112 S. Ct. 2365 (1992). Such a tax could require states to administer their income taxes separate from federal law under the existing IRC.
Another idea receiving serious consideration is the “repatriation tax.” Under it, U.S. corporations will be taxed at a reduced rate, e.g., 5 to 10 percent on earnings now held by foreign subsidiaries. Many states have their own statutes dealing with corporate distributions – deemed as well as actual. It is not clear how states will react to a federal repatriation tax. Will they be able to tax distributions of foreign earnings within their existing laws or will they have to amend them to reach the reported billions of dollars in dividends that might flow back to the U.S.? Similar to the problem Iowa experienced in the Kraft decision, it may not be easy to overcome constitutional issues in this area.
These are areas of keen interest to state revenue officials and taxpayers.
No advances have been made in federal legislation to resolve some long-standing state tax issues such as remote sales tax collection and business entity nexus. With appointment of a new U.S. Supreme Court justice, will the court be more willing to take up the numerous state challenges to the Quill physical presence test, a sales tax doctrine that is now 25 years old?
The fiscal outlook among states ranges from cautious to gloomy. A recent analysis by the National Association of State Budget Officers in its “Summaries of Fiscal Year 2018 Proposed Executive Budgets” (April 2017) observes:
States are currently contending with slow gains in tax collection, with the majority of states having revised their revenue forecast downward for the current fiscal year. Additionally, revenue forecasts for fiscal 2018 project that tax collections will once again grow moderately.
States continue to feel pressure as they try to maintain or increase spending in such areas as education, infrastructure, healthcare and other social welfare programs. If enacted, the recently released federal budget promises to exacerbate this situation. The president is proposing deep cuts in funding for programs that states rely on and whose constituencies may look to cushion the loss of federal money.
Tax cuts are not out of the question in some states, particularly, with respect to personal income taxes. But these may be balanced with increases in business taxes, e.g., new gross receipts taxes and indirect taxes such as sales and excise levies.
Expect further tightening in data security and information protection measures by state taxing agencies as they attempt to stem a rising tide of fraudulent refund claims. This has resulted in a general slowdown of return processing and paying refund claims much to the annoyance of taxpayers. Businesses will continue to see aggressive tax discovery, audit, collection and information sharing on the part of state and local tax officials.
For more on specific state and local tax issues, please see the following sections:
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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.