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The State Tax Impact of Federal Tax Reform The State Tax Impact of Federal Tax Reform

The State Tax Impact of Federal Tax Reform - PowerPoint Presentation

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The State Tax Impact of Federal Tax Reform - PPT Presentation

The State Tax Impact of Federal Tax Reform 2017 SEATA Conference New Orleans Louisiana July 11 2017 Karl Frieden VP amp General Counsel Council On State Taxation AGENDA The Economic and Political Landscape ID: 769977

state tax rate federal tax state federal rate reform income border base current corporate conformity states rates cit depreciation

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The State Tax Impact of Federal Tax Reform2017 SEATA Conference New Orleans, LouisianaJuly 11, 2017 Karl Frieden, VP & General Counsel,Council On State Taxation

AGENDAThe Economic and Political LandscapeState Tax Implications of Federal Tax Reform Key State Tax and Fiscal Impacts 2

The Economic and Political Landscape for Comprehensive Federal Tax Reform

US Income Tax System Out of Step w/ Rest of the WorldWorldwide TaxationTerritorial Taxation 4 CIT Rate 4

The U.S. Relies Less on Border Adjusted Consumption Taxes: 33% OECD vs. 17% US 5

Continued Federal Budget Challenges6 6

Growing Federal Debt7Total 2015 Debt Held by Public = $13.2 Trillion 7

Prospects for Sweeping Federal Tax Reform in 2017Favorable FactorsComprehensive tax reform is a top priority of the Republican party that now controls the Presidency and CongressCompatibility with President-elect Trump’s trade and job creation policies Strong support of Speaker of the House Paul Ryan International tax pressures on the USPressure for a legislative winPotential ObstaclesThe divisions within the Republican party that were on display in the failed (so far) ACA repeal The slim Republican majority if the reconciliation process is used. Differences between the House Blueprint, President Trump’s tax reform proposals, and Senate perspectives Different priorities within the U.S. business communityThe complexity of enacting comprehensive federal tax reform legislation 8

State Tax Implications of Federal Tax Reform

Comparison of House Blueprint and Trump ProposalProvision Current Law House GOP 2016 Tax Reform ‘Blueprint’ Trump April 26 Proposal Corporate tax rate (federal) 35% rate 20% rate 15% rate International tax regime ‘Worldwide’ system with deferral Foreign tax credits to mitigate double taxation ‘Territorial’ system 100% dividend exemption system Territorial system “Deemed” repatriation n.a . Previously untaxed foreign earnings: 8.75% tax rate for cash and cash-equivalents; 3.5% tax rate for non-cash assets. Previously untaxed foreign earnings taxed at low rate (TBD) Border Adjustment n.a . Border adjustment of corporate tax Not included in proposal Cost recovery (full expensing) Recover over the investment’s applicable life (50% bonus depreciation for equipment in 2017,) Full expensing for depreciable and amortizable investments (tangible and intangible) Not included in proposal Business interest expenseDeductible as incurredDeductible only against net interest incomeSpecial rules for financial servicesNot included in proposal Base Broadening n.a.Extensive base broadening by limiting PIT and CIT deductions and credits Extensive base broadening by limiting many PIT and CIT deductions and credits Top individual tax rate39.6% plus 3.8% ACA tax, plus 1.2% phase out of itemized deductions33% rate 35% rate Pass-through businessesTaxed at individual ratesTaxed at individual rates not to exceed 25%15% rate 10

What Is the Senate Thinking? Tax reformLower rates and broader base (like the Tax Reform Act of 1986) Bonus depreciation with current law accelerated depreciation (instead of expensing)No border adjustmentMaintain interest deduction or put some limitations on amount that can be deductedLower tax rate for pass through businessesTerritorial taxation and deemed repatriationSimple tax rate cut 11

Federal Tax Reform: Impact on the States Based on Current IRC LinkageFederalStates Reduce the top corporate income tax (CIT) rate States have own rates Broaden the CIT tax base State conformity Border adjustability State conformity Denial of interest deduction State conformity Expensing investments State conformity Reduced repatriation rate Modest impact Territorial tax regime Minimal conformity Reduce flow-through rate States have own rates Other personal income tax changes States have own rates, but generally conform to base broadening 12

AK HI ME RI VT NH NY CT PA NJ MD DC DE VA WV GA FL IL OH IN MI WI KY TN AL MS AR LA TX OK MO KS IA MN ND SD NE NM AZ CO UT WY MT WA OR ID NV CA MA SC Current (Rolling) Fixed Date Does not incorporate the IRC by reference, but uses Federal Taxable Income as the starting point Conforms only to specified sections No corporate income tax – N/A State IRC Conformity NC Notes AR – only specified sections adopted; various dates AZ – 1/1/16 CA -1/1/15 CT – last day of income year FL – 1/1/16 GA – 1/1/16 HI -12/31/15 IA – 1/1/16 ID – 1/1/16 IN – 1/1/16 KY – 12/31/15 MD – Current unless impact to state of $5MM or more ME – 12/31/15 MI – 1/1/12 MN – 12/31/14 MS – current, but only specified sections adopted NC – 1/1/16 NH – 12/31/00 OH – 4/1/15 OR – 12/31/15 PA – various provisions adopted current and FTI starting point. SC -12/31/15 TX – tax year beginning 1/1/07 VA – 12/31/15 VT – In effect for 2015 WI – 12/31/13 WV – 12/31/15 13

States decoupling from bonus depreciation State conforms to bonus depreciation (Alaska) No general corporate income tax State does not conform to bonus depreciation (Hawaii) Source: Thomson Reuters 14

Border Adjustability: Destination-Based Taxation Border adjustability is one of the most far-reaching and controversial provisions in the House Blueprint. It appears unlikely to be enacted in its current form. Essentially, the provision would favor exports over imports by excluding exports from taxable income and denying a COGS deduction for imports. There are many unanswered implementation issues. Estimated revenues of $1.2 trillion over 10 years. sufficient to fund 10 percentage point reduction in the CIT Even if the BA does not get enacted, will the debate over the importance of VAT-like border adjustments and expensing of investments have an impact on state-level income and consumption taxes? 15

Border Adjustability: The Shift to Destination-Based State Corporate Income Taxes - 2017 AK HI ME RI VT NH MA NY CT 1 PA NJ DC DE 4 WV NC 4 SC GA FL IL OH IN MI WI KY TN AL MS 5 AR LA TX OK MO KS IA MN ND 2 SD NE NM 4 AZ 3 CO UT 2 WY MT WA OR ID NV CA VA MD Key Equally weighted three-factor formula Double-weighted sales factor Triple or greater weighted sales factor Single-sales factor 16

State Sales Taxes: The Limited Recovery of Business Investments Business Input Purchases Account for 42 percent of Sales Tax Base N/A N/A 57% 28% 41% 45% 47% 34% 53% 53% 49% 45% 55% 52% 53% 43% 49% 43% 46% 40% 40% 33% 32% 37% 51% 32% 36% 29% 35% 46% 34% 55% 44% 53% 37% 36% 33% 34% 41% 36% VT 40% MA 39% CT RI 49% 46% NJ 39% MD DC HI 33% 32% 42% 17

Key State Tax and Fiscal Impacts

Federal Budgetary and Other EffectsHouse Blueprint purports to be revenue neutral (using ‘dynamic’ scoring); President’s principles do not address revenue consequencesDeficit financing of tax cuts will impose fiscal constraints on federal government and its ability to finance intergovernmental programsOther proposals simultaneously shifting responsibilities to states or constraining resourcesMedicaid financingRepeal of deduction for state and local taxesAccounts for about $1.8 trillion (over 10 years) of the $2.3 trillion PIT base broadening at the federal level.Increases the after-tax costs of state and local government at a time when federal resources will be constrainedRepeal of exclusion for state and local bond interest would increase the cost of state and local government financingLower federal tax rates for pass through entities could accelerate shift away from C Corporation structures and reduce state tax revenuesCurrently, at the state level, C Corporations (with two levels of taxation) pay an effective tax rate that is 30 percent higher than that paid by pass through entities

What to Expect from States?Prospects for state reductions in rates is unclear (at best)Any state base broadening likely to be relatively less than at federal level because of lack of conformity and other issuesState fiscal conditions may not allow for it, and deficit financing not allowedMany states experiencing fiscal difficulties at the present timeImpact of reform is to further restrain resources and increase responsibilitiesLimited pressure for state reductions in pass-through rates unless they also reduce regular corporate rateStates will need to weigh the costs and benefits of conformity to new federal provisions Federal change may be of sufficient magnitude and uncertainty to cause a variety of state reactions Freeze things in place in near-termConsider alternatives to the corporate income tax (e.g. gross receipts taxes; expanded sales tax)Offset regressivity or other impacts of federal tax reform