States will likely opt out of extending the full swath of federal pandemic relief to their businesses, as they face shuttered state houses and potentially limited benefits.
The federal tax code changes in the latest stimulus law (Public Law 116-136) are meant to help businesses suffering from economic upheaval during the pandemic. Included in the package was a temporary increase of the tax code Section 163(j) limit on deductions for business interest payments to 50% from 30% of adjusted taxable income.
States facing dire revenue constraints as a result of the economic fallout from the pandemic may conclude they aren’t in a position to offer that relief, tax professionals said. One week after the law took effect, New York decoupled from the provision, the first state to say it would stray from the law.
“The federal government can afford to provide refunds and liquidity,” said Todd G. Betor, counsel at Eversheds Sutherland (US) LLP in Washington. “The federal government can print money. The states do not.”
Pick and Choose
New York and about a third of the states are “rolling-conformity” states that adopt federal tax code changes as they occur. Another 20 or so states are “fixed-date conformity,” meaning they conform to the changes on a date they set, or “selective,” meaning they conform to some changes on a rolling basis and others on a specified date.
Other rolling-conformity states include Illinois, Massachusetts, New Jersey, and Tennessee. Fixed-date conformity states include Arizona, Florida, Georgia, Michigan, and Texas, according to a BDO USA LLP report.
The business interest expense deduction in 163(j) used to be unlimited at the federal level, and when the 2017 tax law limited it to 30%, several states—Connecticut, Indiana, Missouri, South Carolina, and Wisconsin—decoupled from the section outright, according to BDO.
“That’s part of being in the state legislature, there are always these tradeoffs,” said Scott Smith, state & local tax national technical practice leader for BDO in Nashville. “They’re trying to balance their own revenue needs with the needs of their constituents and the business community.”
A handful—Arkansas, California, and Georgia—continue to follow the pre-tax overhaul version of the section. A few others never conformed to it, and still don’t. For these states, the federal 163(j) revisions won’t apply.
The stimulus law also relaxes several restrictions on net operating losses, allowing businesses to carry back losses generated in 2018 through 2020 for up to five years. The 2017 tax law had barred carrybacks.
The benefits of the CARES Act NOL revisions also will be limited at the state level, given that most states already disallow NOL carrybacks. But since the changes likely will result in federal returns being amended, state returns will need to be amended as well.
Most legislatures are already adjourned for the year or suspended indefinitely, and any action they take once they return may be too late.
And, even if legislatures are able to meet and adapt to the stimulus revisions, “It’s going to be very difficult for state taxing authorities to deal with them given that a lot of their personnel are working from home,” said Joe Huddleston, executive director of state and local tax services for EY LLP.
The fiscal stress facing states is of historic proportions, according to a report by the Center on Budget and Policy Priorities that said shortfalls could total more than $500 billion in the coming fiscal year. Even after accounting for federal aid and rainy day funds, states will have sharp revenue losses and significant new costs associated with fighting Covid-19, the report said.
One thing for states to consider is that the federal tax changes are a type of “well-targeted relief” that can help companies struggling with liquidity, said Jared Walczak, director of state tax policy at the Tax Foundation.
“In this situation, they may have no choice but to take on debt, so reducing the business cost of doing so has real value right now,” he said. “This isn’t just a randomly chosen form of tax relief—it’s not a check to businesses.”
Walczak and others said it’s too early to tell how much the change in the 163(j) limit will cost the states.
“We don’t have hard numbers, but there’s no doubt it will reduce general fund revenues even more” amid projections of reduced tax revenues and increased costs to fight Covid-19, said Kate Watkins, chief economist in the Colorado Legislative Council.
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