The Tax Cuts and Jobs Act (TCJA) contains the most sweeping and significant changes to the Internal Revenue Code (IRC) in 30 years. At the federal level, the TCJA includes a myriad of tax provisions that, overall, broaden the federal tax base while reducing federal tax. There has been a flurry of analysis and discussion regarding the TCJA’s impact on the federal taxation of business entities and individuals, and some of that impact remains uncertain due to some ambiguity in applying the TCJA’s rules. However, what should not be overlooked as well is the arguably greater uncertainty of the impact that the TCJA will have at the state level, i.e., the implications to a state’s tax base, and how each state’s legislature and taxing authority will respond. 

This state impact will greatly depend on how each state decides to conform or not conform to the new federal tax laws. This in turn may depend to some extent on a state’s starting point for its taxable income, be it an individual’s taxable income or a corporation’s taxable income, i.e., whether that starting point is federal AGI, federal gross receipts, federal taxable income, or something else.  For instance, an individual filing in a state that uses as a starting point something other than federal taxable income may be precluded from reducing their state taxable income by the amount of the new IRC Section 199A pass-through entity deduction, unless the state issues guidance or passes legislation that would allow such deduction.  

Below is a summary of state responses to the TCJA (through July 31, 2018) and of some items of considerations in light of those responses.

State approaches to adopting federal tax laws

All states that impose an individual income tax and/or a corporate income tax conform to the IRC in some manner. There are three general state approaches to IRC conformity: rolling, static, and specific reference.

States with rolling conformity automatically adopt federal tax law changes as those occur.  However, some of these states have routinely enacted laws that decouple from certain federal tax provisions.  Currently, rolling conformity is used in 18 states plus the District of Columbia for individual income taxes and in 22 states for corporate income taxes.

States with static or fixed-date conformity do not automatically adopt federal tax law changes. Instead, these states conform to the IRC as of a specific date. As such, for these states to conform to federal tax law changes, their conformity dates must be updated. Nineteen states currently have “static” conformity for individual income taxes, and 21 states follow this approach for corporate income taxes.

States that conform to the IRC by specific reference incorporate a specific federal provision either by addressing the provision in a specific state tax statute or by specific reference to the IRC section at issue. Five states use “specific reference” conformity for individual income taxes, and three do so for corporate income tax purposes.

Federal tax reform provisions

With respect to some major TCJA provisions, some potential state-tax implications are as follows. 

Business Entity Tax Provisions

Individual Tax Provisions

State responses to federal tax reform

• Currently, only six states have passed legislation to conform to aspects of the TCJA.  These states are Georgia, Idaho, Oregon, Virginia, West Virginia, and Wisconsin. 
• Connecticut, Maryland, New Jersey, and New York have filed suit against the federal government to directly challenge the $10,000 SALT deduction cap.
• Several states have announced a workaround for the SALT deduction cap. Namely, California, New Jersey, New York, and Rhode Island are all considering establishing public-purpose funds in which taxpayers could make donations that they state would be eligible for a federal charitable contribution deduction.  The taxpayer would also receive a state income or municipal property tax credit for some portion of the contribution. However, the IRS has recently released Notice 2018-54, announcing the Treasury Department’s intention to issue proposed regulations on SALT workarounds involving charitable contributions. This could mean that the Treasury view is that these workarounds will not work in providing a federal charitable deduction for taxpayers.
• Additional SALT cap countermeasures: Connecticut has passed an entity-level tax on flow-through entities. The tax is deductible on the entity’s federal tax return, and owners of a flow-through entity receive a corresponding tax credit against their state individual income tax. New Jersey is considering imposing similarly an entity-level tax on flow-through entities, with the owners of a New Jersey flow-through entity to receive a corresponding tax credit against their New Jersey individual income tax. 

Winners and losers

States that conform to the now repealed federal personal exemption, such as Maine, should realize the largest revenue increases under the TCJA.   It is expected that most states will benefit from modifications to deductions for mortgage interest and moving expenses. The SALT deduction cap of $10,000 would increase revenue for 24 states and the District of Columbia.

Absent legislative action, six states that use federal taxable income as their income starting point may experience revenue losses, because of the new IRC Section 199A pass-through entity income deduction.  

As of the end of 2017, it is estimated that U.S. corporations had accumulated about $2.5 trillion in overseas earnings.  Prior to the TCJA, United States corporations paid taxes on income earned overseas, but the tax liability was deferred until the income was repatriated. Pursuant to the TCJA, these deferred overseas earnings were deemed to have been repatriated as of the end of calendar year 2017, making them immediately subject to federal taxation. This deemed repatriated income is characterized as Subpart F income. States that conform to Subpart F may therefore experience a windfall from this deemed repatriation.  It is expected that states that had not been taxing Subpart F income will likely be unable to retroactively conform to take advantage of this tax reform provision. 

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