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Prospects of More Decoupling From I.R.C. Raise Concerns About Complexity, Federal Indifference to State Fiscal Needs

H.R. 5297's federal tax breaks could further deplete state revenues. BNA addresses the tendency of states to resort to decoupling from federal measures.

October 14, 2010
Sponsored by BNA Tax & Accounting

The prospect of another round of state decoupling from recently enacted federal tax breaks feeds a growing concern about the apparent indifference of federal policymakers to state fiscal problems, several state tax specialists told BNA.

"Every time the federal government acts to expand or contract the tax base, the states must react by increasing their tax rates or decoupling from the federal provisions," said Walter Hellerstein, professor of law with the University of Georgia. "It's a messy complicated process. There's something dysfunctional about the lack of coordination."

The recent enactment of H.R. 5297, which includes an extension of 50 percent bonus depreciation and an increase in I.R.C. §179 expensing limitations, leaves states with "two bad choices," Hellerstein said. States can either "adopt bonus depreciation and face acute budget problems or ... decouple and contribute to complexity and difficulty in administration."

"As we talk with state legislators and state tax administrators, we're finding a growing sense — part of it may be frustration, that there is a disconnect between the federal government and the states in recognizing the fiscal interrelationships they have," said Harley Duncan, a managing director in the State & Local Tax practice of KPMG LLP.

"The legislators will say `we've been trying to cope with budget shortfalls and trying to balance the budget for three years now, and we have a couple more years to go, and still we keep getting one federal enactment after another that detracts from our revenue base,' " Duncan said.

Said Hellerstein, "This lack of fiscal coordination is another example of the breakdown of civility in government. There's an increasing indifference at the federal level to the likely consequences that tax policies will have on states."

Tax Breaks for Small Business

The Small Business Jobs and Credit Act of 2010 (H.R. 5297), enacted September 27, also includes a temporary exclusion of the gain on certain small business stock, a temporary reduction in the recognition period for built-in gains tax, and an increase in the amount allowed as deduction for start-up expenditures in 2010.

Because many states base their income taxes on federal taxable income, these changes have implications for state revenues. A reduced federal base translates into a shrunken base for states, most of which have been grappling with severe budget shortfalls for several years and can ill afford to absorb even a minor revenue loss.

Whether a state decouples sometimes depends on how it conforms to the Internal Revenue Code. About half the states automatically conform. The others conform to the I.R.C. as of a specific date.

The states that automatically conform must adopt legislation in order to decouple from specific I.R.C. provisions. The others can decouple from certain provisions by changing the date of overall conformity — or in some cases, by declining to change the date of conformity. New Hampshire, for example, conforms to the version of the I.R.C. in effect on Dec. 31, 2000.

Not a New Development

The pressure on states to decouple from federal efforts to stimulate the economy is not a new development. The Job Creation and Worker Assistance Act of 2002 — enacted during a recession — provided an additional first-year depreciation to encourage investment. Ultimately, about 30 states decoupled from the provision.

States have since decoupled from various other provisions — including bonus depreciation provisions that apply to the 2008 and 2009 tax years, federal net operating loss provisions, and federal treatment of cancellation of indebtedness income. In fact, the Center on Budget and Policy Priorities (CBPP) has urged decoupling in the past as a means of generating revenue. In 2008 the CBPP issued a paper suggesting that states could recoup some $470 million in lost revenues if they decoupled from I.R.C. § 199, the federal domestic production deduction.

H.R. 5297, among other things, extends the applicability of bonus depreciations provisions under I.R.C. § 168(k) for one year and expands enhanced expensing rules under I.R.C. § 179. All but about a dozen states that impose income tax have already decoupled from federal bonus depreciation provisions. Nearly half the states have opted against following the federal enhanced expensing rules.

For taxpayers, the prospects of further state decoupling from the I.R.C. means not only the loss of a tax benefit at the state level — but the additional cost of compliance, according to Karen T. Syrylo, state taxation consultant with the Maryland Chamber of Commerce.

"A state like Maryland has already decoupled from many of the [federal] provisions on a permanent basis, and then on an item-by-item basis," Syrylo said.

"Maryland's form for decoupling has grown — it's much larger than it used to be — and it gets even more complicated with so many companies having net operating losses. You have to track not only your own NOL carry forward, but the addition and subtraction modifications from that year."

Need for a Forum

The actual impact of H.R. 5297 on state coffers has not yet been calculated, according to Jim Eads, executive director of the Federation of Tax Administrators.

"Most legislatures are not in session right now," Eads said, "but I'm sure tax administrators and governors' offices are looking at the provisions and, in particular, the fiscal implications of them, and they'll be coming forward with proposals when the legislatures come together after the first of the year."

Eads told BNA he did not think the lack of uniformity among state corporate tax codes was creating a problem with tax compliance. But the federal government needs to be more aware of the impact of its actions on the states.

"There needs to be a systematic way of consultation," Eads said. "The states don't want to have — and could not have — any veto power over changes at the federal level, but the federal government has an obligation to consult with — and be respectful of — the fiscal needs and fiscal conditions of the states."

How to make that happen is "the $64,000 question," according to Duncan, who noted that there is no institutional forum for bringing state tax officials together with federal tax policymakers. What may be needed is a something similar to the Advisory Commission on Intergovernmental Relations (ACIR), which was disbanded in 1996.

Effect on Competitiveness

The ACIR was organized as an independent, bipartisan intergovernmental agency, established under Pub. L. No. 86-380 in 1959 in order to "strengthen the American federal system and improve the ability of federal, state, and local governments to work together cooperatively, efficiently, and effectively." Douglas L. Lindholm, executive director of the Council On State Taxation (COST) in Washington, D.C., told BNA he agrees that such a forum is necessary in order to consider the collective actions of federal and state governments.

Lack of uniformity among state tax codes has reached a critical point, he said, and requires congressional intervention. Differing nexus standards among states, varying withholding laws that hamper workforce mobility, and disparate sales and use tax laws all create burdens on multistate corporations. "There's an issue of global competitiveness," he said. To the extent that "complying with the sub-national tax system in the United States grows more complex, it will make the United States a less desirable place to do business than other parts of the world."

A Broader Problem

Joe Huddleston, executive director of the Multistate Tax Commission, said he does not believe that state decoupling from specific provisions of the I.R.C. "significantly increases" complexity and compliance problems. Rather, he said, it is symptomatic of a much broader problem — that corporate taxpayers are increasingly going to Congress to seek legislation impinging on states' ability to raise revenues. "Whether it's rental cars, or Internet travel companies, or whether it's big Internet retailers or whether it's multinational financials — there is a laundry list of companies who are on the Hill every day pursuing what they perceive to be their own best interest," Huddleston said. "But I'm not sure what they're asking for is what they really want."

The more private industry seeks federal solutions, the more pressure will come to bear on states to create carve-outs from the federal code.

"The major national and international companies who make the argument to let Washington take charge — they miss a broader point here," Huddleston said. "Should Washington take charge of all this, the opportunities they have for negotiating credits, negotiating deals with the states — that will go away. So I'm not sure they would be all that happy with a single, uniform national state tax base."

The chart below details each state's approach to conformity to the I.R.C. "Current" signifies that the state adopts the most recent version of the I.R.C. without the need to enact additional legislation. A specific date shows that the state conforms to the version of the I.R.C in effect as of that particular day. It also lists each jurisdiction's conformance to bonus depreciation and enhanced expensing provisions, which were extended under H.R. 5297. These tax breaks were enacted and extended under the Economic Stimulus Act of 2008 (P.L. 110–185) (enacted Feb. 13, 2008) and American Recovery and Reinvestment Act of 2009 (ARRA) (P.L. 111–5) (enacted Feb. 17, 2009). The enhanced expensing rules were extended under the Hiring Incentives to Restore Employment (HIRE) Act (P.L. 111–147) (enacted March 8, 2010).

State I.R.C. Conformity Bonus Depreciation Enhanced Expensing Authority
Alabama Current No for 2008; Yes for 2009 and thereafter No for 2008; Yes for 2009 and 2010 Ala. Code §40-18-1.1; "Decoupling of Alabama Income Tax Law from the Bonus Depreciation and Additional Section 179 Provisions of the Federal Economic Stimulus Act of 2008 (March 11, 2009)
Alaska Current Yes Yes Alaska Stat. § 43.20.021
Arizona Jan. 1, 2010 No No Ariz. Rev. Stat. Ann. §§ 43-105; 43-1021(27)
Arkansas Various versions with Jan. 1, 2009 being most current No No Ark. Code Ann. § 26-51-404 and §26-51-428
California Jan. 1, 2009 No No Cal. Rev. & Tax. Code § 23051.5.
Colorado Current Yes Yes Colo. Rev. Stat. §§ 39-22-103 and 39-22-304
Connecticut Current No Yes Conn. Gen. Stat. §§ 12-213(a)(23) and 12-217(b)
Delaware Current Yes Yes Del. Code Ann. tit. 30, §§ 1901(12) and 1903
District of Columbia Current No No D.C. Code Ann. §§ 47-1801.04(28A); D.C. Code Ann. §47-1803.03
Florida Jan. 1, 2010 No No Fla. Stat. §§ 220.03(1)(n), 220.13
Georgia Jan. 1, 2010 No Yes for 2009 Ga. Code Ann. § 48-1-2(14)
Hawaii Dec. 31, 2009 No No Haw. Rev. Stat. §§ Haw. Rev. Stat. §235-2.3
Idaho Feb. 17, 2009 Yes Yes Idaho Code §§ 63-3004 and -3022O
Illinois Current No Yes 35 ILCS 5/1501(a)(11); 35 ILCS 5/203(b)(2)(E-10); 35 ILCS 5/102 and 5/1501(a)(11)
Indiana Jan. 1, 2010 No No Ind. Code Ann. §§ 6-3-1-11 and 6-3-1-3.5
Iowa Jan. 1, 2008 No No Iowa Code Ann. §422.3; Iowa Dept. of Rev., "Iowa Status on Federal Extenders for Tax Year 2009"
Kansas Current Yes Yes Kan. Stat. Ann. §79-32,109(a)
Kentucky Dec. 31, 2006 No No Ky. Rev. Stat. Ann. §141.010
Louisiana Current Yes Yes La. Rev. Stat. Ann. §47:287.701(A)
Maine March 2, 2010 No No Me. Rev. Stat. Ann. tit. 36, § 111(1-A); Maine Rev. Svcs., "Maine Income Modifications Related to Bonus Depreciation and Section 179 Expensing," (Jan. 2010)
Maryland Current No No Md. Code Ann. Tax-Gen. §§10-210.1(b)(1) and 10-310; Maryland Administrative Release No. 38 (Sept. 2010)
Massachusetts Current No Yes Mass. Gen. L. ch 63, §§ 30(17) and (4)(iv), 1
Michigan Current or Jan. 1, 2008 at taxpayer's option No Yes Mich. Comp. Laws §§ 208.1111(3), 208.1109(3), and Mich. Dept. of Treas., FAQ B. 51 (Aug. 26, 2009)
Minnesota March 18, 2010 No No Minn. Stat. §290.01
Mississippi Current No Yes Miss. Code Ann. §§ 27-7-103 and 27-7-17(1)(f)
Missouri Current Yes Yes Mo. Rev. Stat. §§ 143.091 and 143.121(2)(c)
Montana Current Yes Yes Mont. Code Ann. §§ 15-31-113 and -114
Nebraska Current Yes Yes Neb. Rev. Stat. § 77-2714; Nebraska Revenue Ruling 99-08-2 (Oct. 6, 2008); Neb. Dept. of Rev. "Nebraska Tax Law Changes Resulting from the American Recovery and Reinvestment Act (ARRA) of 2009" (March 19, 2009)
Nevada N/A N/A N/A N/A
New Hampshire Dec. 31, 2000 No No N.H. Rev. Stat. Ann. § 77-A:1.XX
New Jersey N/A No No N.J. Rev. Stat. § 54:10A-4(k)
New Mexico Current Yes Yes N.M. Stat. Ann. § 7-2A-2
New York Current No Yes N.Y. Tax Law § 208
North Carolina May 1, 2010 No Yes N.C. Gen. Stat. §§ 105-228.90(b)(1b), 105-130.5(a)(15), and 105-228.90
North Dakota Current Yes Yes N.D. Cent. Code § 57-38-01.
Ohio Oct. 16, 2009 No No Ohio Rev. Code Ann. § 5733.04
Oklahoma Current, but Franchise tax suspended from July 1, 2010, and ending before July 1, 2013. Replaced by BAT. No No Okla. Stat. Ann. tit. 68, § 2353(2)
  Dec. 31, 2009 No No Or. Rev. Stat. §§ 314.011, 317.010(7); Or. Dept. of Rev., "2009 Corporate Tax Law Changes"
Pennsylvania Current No Yes 72 Pa. Cons. Stat. § 7401(3)
Rhode Island Current No No R.I. Gen. Laws §§ 44-11-11, 44-61-1, and 44-61-1.1
South Carolina Dec. 31, 2009 No Yes S.C. Code Ann. §§ 12-6-40 and -50, 12-6-40
South Dakota N/A N/A N/A  
Tennessee Current No Yes Tenn. Code Ann. §§ 67-4-2004, 67-4-2006(b)(1)
Texas Jan. 1, 2007 No No Tex. Tax Code Ann. §§171.0001(9) and 171.1011(c)(1)
Utah Current Yes Yes Utah Code Ann. § 59-7-101
Vermont Jan. 1, 2009 No Yes Vt. Stat. Ann. tit. 32, §§ 5811(7) and 5824
Virginia Jan. 22, 2010 No Yes for 2009 Va. Code Ann. § 58.1-301; Virginia Tax Bulletin VTB 10-4 (March 30, 2010)
Washington N/A N/A N/A  
West Virginia Jan. 1, 2009 through Dec. 31, 2009. Yes Yes W. Va. Code § 11-24-3
Wisconsin Dec. 31, 2008 No No Wis. Stat. § 71.22(4)(t), and (4m)(r)
Wyoming N/A N/A N/A  

Dolores W. Gregory is an editor with BNA. Steven Roll is assistant managing editor for state tax.

Copyright © 2010 by The Bureau of National Affairs, Inc.