Multinational corporations will have to wait longer to find out how states will tax their offshore earnings as legislatures pivot to handling the public health crisis.
Legislative sessions opened in January with expectations that several states might pass legislation or issue guidance on how state tax obligations are affected by the 2017 federal tax law’s global intangible low-taxed income, or GILTI. The business-focused Council on State Taxation (COST) had high hopes, particularly for action in Colorado, Iowa, Kansas, Nebraska and Utah, which all tax the new category of foreign income but offer little guidance to taxpayers.
COST had pushed for business-friendly bills barring state revenue departments from taxing GILTI, but those measures are sidelined so lawmakers can use their dwindling time and resources to address the pandemic.
“The entire 2020 legislative sessions have been derailed by Covid-19,” said COST general counsel Karl Frieden. “This issue, GILTI, is sidetracked for now.”
For instance, action in Iowa and Nebraska, two states still considering taxpayer-favorable GILTI legislation, remains stalled because the measures are seen as revenue losers at a time when states are bleeding cash.
“It is certainly harder to make any revisions to the tax code that could result in a reduction in revenues, even if the state never intended to tax that activity it in the first place,” said Jared Walczak, director of state tax policy at the Tax Foundation. “States are tightening their purse strings and scrounging for any additional revenue.”
Business groups have generally opposed state efforts to tax GILTI, arguing state taxing authorities shouldn’t extend beyond national borders, or the “water’s edge.” Multinationals claim their international income shouldn’t be included in state tax bases because state codes fail to account for foreign factors of production. They also point to potential constitutional problems, noting states taxing GILTI could be vulnerable to claims of disparate treatment between multinational and domestic taxpayers.
Patchwork of Laws
GILTI, under federal tax code Section 951A, was designed to discourage multinationals from shifting income from intangible assets, such as patents and trademarks, to low-tax countries. States often conform their laws to the federal tax code to adjust to changing tax bases, boost revenues to fund state services, or remain competitive.
States have generally declined to include foreign income in their tax bases, and corporate taxpayers have lobbied for similar treatment for GILTI. But GILTI has been complex for states to address and a patchwork of regulation has emerged over the last two years.
Twenty one states have decoupled from the foreign income provisions and don’t tax GILTI, while six states don’t have corporate income taxes. Another 18 states tax GILTI, but not all of them tax the same way.
Most bills introduced earlier this year are either dead or stalled.
Lawmakers in Utah considered S.B. 53, which would have subtracted GILTI from the corporate income tax base. But a block of lawmakers opposed the measure, frustrated with a previous round of corporate tax breaks and fearful of revenue losses due to the pandemic, said John Valentine, chair of the Utah State Tax Commission.
Utah’s legislative session ended in March without action on the measure.
Meanwhile, Nebraska is considering L.B. 1203 after the Nebraska Department of Revenue issued guidance directing corporate taxpayers to include GILTI in their tax calculations. The measure specifies GILTI to be treated as foreign dividends received and subtracted from a taxpayer’s federal adjusted gross income.
But Kristen Hassebrook, vice president for legislation and policy for the Nebraska Chamber of Commerce, conceded the bill has little chance of success, particularly after a fiscal note projected significant revenue losses.
“I’m not very optimistic,” she said. “There will be a lot of hesitancy to work on this and all sorts of things because of the unknown revenue impacts to the state.”
And Kansas is considering H.B. 2553, which would subtract GILTI from the corporate income tax base, retroactive to 2018. The bill, however, failed to advance since its introduction in early February. The state revenue department estimates the bill would cut revenues by $95.6 million in fiscal year 2021 and $24.2 million the following year.
Iowa lawmakers began crafting legislation to deal with GILTI after the state Department of Revenue published a rule requiring businesses to recognize GILTI on their state tax returns and featured a formula for apportioning GILTI within Iowa.
The state House responded with House Study Bill 708, which permits GILTI to qualify for existing deductions for foreign dividend income and subpart F income, retroactive to 2019. But the bill has made little progress since it was introduced in early March.
Corporate taxpayers, however, are crossing their fingers.
“There is a chance they will do it because I’m not sure they will necessarily want to go into an election year raising taxes on businesses at one of the worst times in history for Iowa,” said Tom Sands, president of the Iowa Taxpayers Association.
The Colorado Department of Revenue’s tax policy section is drafting rules that address the taxation of GILTI and plans to meet with stakeholder groups next month though a “virtual rulemaking hearing,” said department spokesman Daniel Carr.
“The Covid emergency set us back some in the rulemaking process, particularly because it diverted our attention to emergency rulemaking,” Carr said. “Nevertheless, we are continuing to work on GILTI and more broadly on foreign-source income rules and hope to have some drafts available for stakeholder review soon.”
Despite the legislative failures, there might be a second bite at the apple in 2020, said Jamie Yesnowitz, a principal and state and local tax practice and national tax office leader at Grant Thornton LLP.
The fiscal distress triggered by the Covid-19 pandemic will likely require more than a dozen states to hold special legislative sessions to address budget shortfalls. During such gatherings, major spending and tax issues, including GILTI, would be on the table, Yesnowitz said.
He added federal tax conformity would be a major agenda item in light of the business tax provisions in the most recent virus relief bill. Several provisions modify business taxes, and states will have to decide if they want to accept or reject the federal strategies, including the business interest expense deduction limitation, new net operating loss limitations, and bonus depreciation rules for qualified improvement property.
“Their budgets are in disarray and there is a strong likelihood that states will decide to have special sessions,” he said. “In many cases, they will decide on state specific tax provisions that may or may not be helpful to taxpayers because they are in dire straits.”