Do all US States Conform to Federal Tax Law?

  • By Eugene Nayyer
    • 21 Dec, 2022
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Do all US States Conform to Federal Tax Law?

It comes as no surprise that the United States taxation system is not the easiest one to navigate. If we add different laws and regulations imposed by 50 states and the District of Columbia to the mix, the task may become extremely challenging. One would hope that states would fully conform to the federal taxation laws. However, this is far from reality. 

Below please find select examples that show differences between various federal tax laws and select state tax laws on the same tax matter: 

Texas for instance does not permit bonus depreciation deduction allowed under the Internal Revenue Code (I.R.C.) section 168(k). This is because the Texas’ franchise tax law is tied to the Internal Revenue Code in effect as of January 1, 2007, when bonus depreciation provisions did not exist. 

Another good example is California and how that state treats asset depreciation. Corporate depreciation deduction is different for California and federal income tax purposes.  California corporation taxpayers must separately compute their California depreciation deduction. If the depreciation amount claimed for federal purposes exceeds the amount calculated for California purposes, then the excess must be entered as an addition adjustment on the return. If the depreciation amount calculated for California purposes exceeds the amount claimed for federal purposes, then the excess is entered as a subtraction adjustment on the return. California also deviates from the $1M asset expense limit allowed by the I.R.C. section 179 and permits only up to $25,000 to be expensed instead. Any amount of the I.R.C section 179 deduction claimed on the federal return that exceeds $25,000 (potentially further reduced by the $200,000 California phaseout threshold) is to be added back to the California taxable income. 

Global Intangible Low-Taxed Income

Another area that has different tax treatment between federal and state pertains to the Global Intangible Low-Taxed Income (GILTI) inclusion provisions found in the I.R.C. Section 951A. For example, Florida allows deducting GITLI amount included in federal taxable income. New Jersey requires including GILTI in net income and Texas does not conform to the I.R.C. section 951A at all. 

Consolidating Reporting Requirements

When it comes to consolidated reporting requirements there are different ways in which even the states themselves dictate how to report them. Florida, for instance, does not permit the filing of combined reports. Instead, Florida requires separate reporting unless an election is made to file a consolidated return. California, however, requires worldwide combined reporting for unitary businesses that derive income from sources within and outside of the state. This is unless a water’s-edge election is made. Finally, many states, including New York and Texas require water’s-edge combined reporting for affiliated groups engaged in unitary business. 

I.R.C. Section 41

Lastly, the I.R.C section 41 allows businesses to benefit from the Research and Development (R&D) credit. Connecticut has a similar provision for the corporate state income tax; however, the calculations to arrive at the credit amount deviate significantly from the I.R.C. section 41. West Virginia permitted the strategic research and development tax credit; however, the credit expired on January 1, 2014. In general, many states have the R&D credit tax provisions. However, these states usually do not exactly follow the I.R.C. section 41 rules when it relates to credit amount determinations, etc. 

The above discussion are some of the examples of how states deviate from federal tax laws, but the list goes on and on. 

In today’s world of high mobility, many businesses conduct operations in many states in addition to their home state. Having such a complex tax system, it is very important for businesses to be familiar with different rules and regulations. Familiarity will ensure tax law compliance and to have a solid defense should states decide to audit company’s operations. 

Author

Eugene Nayyer
Eugene Nayyer

SALT Consultant

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