Legislative Task Force on the Impact of the Tax Cuts and Jobs Act Releases Its Final Report
SALT Alert: Alabama Edition
The Alabama Legislature was stymied last year over proposals to decouple from or conform with various provisions of the Tax Cuts and Jobs Act of 2017 (TCJA). As a compromise, the Legislature formed a Joint Legislative Task Force pursuant to Senate Joint Resolution 87 (Alabama Act 2019-339) to study these issues. After extensive deliberation and research, as well as discussions with Alabama Department of Revenue and Department of Commerce officials, industry and tax professionals, the task force delivered its final report to the Legislature on February 18.
The bipartisan task force was led by well-respected Senator Dan Roberts (R) and Representative Danny Garrett (R), and included Representatives Joe Lovvorn (R) and Rod Scott (D) and Senators Vivian Figures (D) and Arthur Orr (R). The thorough, well-documented 59-page report (“Final Report”) focused not only on TCJA conformity issues, however, but on several other business tax issues, including whether to adopt unitary combined reporting and to move from the current double-weighted sales factor to a single sales factor formula. Co-Chair Roberts explained:
Our Task Force originally set out to address Tax Cuts and Jobs Act conformity issues such as section 163(j) and GILTI. Our research quickly led us to more critical issues arising from the effect of our peculiar federal income tax deduction. Through TCJA, dramatic State tax increases were imposed on our corporations and pass-through entity owners by simply doing nothing. Those changes were automatically incorporated into our corporate income tax code, coupled with the reduced FIT deduction resulting from the TCJA tax breaks. Alabama moved from one of the lower effective corporate tax rates to among the highest in our region.
What effective tax rate advantages we do have are masked by the FIT deduction. As a result of that deduction, our effective rate is substantially less than our statutory 6.5% rate, but that’s often overlooked by companies considering Alabama for their new facility.
Once we focused on competitive issues, we also came to recognize that surrounding states are exploiting apportionment methods to our disadvantage. In short, we knew that a comprehensive response to the TCJA was best for our state.
The Final Report was quick to point out that, because of Alabama’s rolling conformity to the Internal Revenue Code for purposes of our corporate income tax, most of the TCJA corporate income tax changes were automatically incorporated into Alabama law, without any input from the Alabama Legislature. The Final Report referred on several occasions to the TCJA state impact study performed for the State Tax Research Institute by Ernst & Young LLP (the “EY Study”) to illustrate that point. The task force warned, however, that the EY Study “did not take into account the state tax windfall generated by Alabama taxpayers’ lower FIT (federal income tax) deductions…,” concluding that the increase in Alabama corporate income tax revenues caused directly or indirectly by the TCJA far exceeded the EY Study’s projected 11% to 12% increase.
Decoupling from TCJA Provisions
The Final Report recommends decoupling entirely or in part from three TCJA provisions: IRC sections 163(j), 951A (GILTI), and 118. Although the task force recommended total decoupling from GILTI and section 118, it recommended only limited decoupling from section 163(j), focusing on corporations that for Alabama income tax purposes either file separately (in most cases) or as part of a nexus-only consolidated group. In certain cases, large amounts of interest expense paid by the parent company on debt incurred on behalf of the entire affiliated group are “trapped” at the parent company level and disallowed, unless rules similar to those adopted by the section 163(j) regulations were adopted to allow offset of interest expense and interest income within the consolidated group. The task force concluded that if an Alabama corporate taxpayer was a member of a federal consolidated group, and that group was not subject to a 163(j) limitation, then the Alabama corporation would likewise be exempt from those provisions. Beyond that, the task force concluded that Alabama should not decouple from 163(j) for corporate income tax purposes.
What seemed to be easiest decision of the task force involved decoupling from GILTI (and FDII) and from section 118. The Final Report cited a persuasive COST study for the former proposal, while mentioning the irony of a state taxing certain types of incentives or subsidies granted either by its own agency or a political subdivision to an industry promising to expand its existing facility or locate new facilities in Alabama.
Tax Rate Reduction
The increased revenue caused by the TCJA also concerned the task force with respect to making Alabama more competitive with its regional neighbors. The report points out that Alabama and Louisiana have the only two full federal income tax (“FIT”) deductions, both of which are embedded in their respective state constitutions. As a result, Alabama’s 6.5% statutory tax rate for both C corporations and banks is misleading because the effective tax rate is substantially lower, after factoring-in the FIT deduction. The task force therefore recommended that the FIT deduction be repealed, while simultaneously reducing the corporate income tax and bank tax rates to 4.75%. The report also recommended that the Legislature address the regressive nature of the state income tax for individuals “and consider measures, including eliminating the FIT and reducing individual tax rates.” However, the report concluded that the task force “did not have sufficient funding or time to arrive at a specific recommended individual statutory tax rate…”
Adoption of Single Sales Factor
As mentioned, the task force also delved into formulary apportionment of multistate business income, recommending adoption of a single sales factor while repealing the much-maligned throwback rule. The task force also met with representatives of the economic development community and ADOR, along with a number of multistate companies doing business in the state, to discuss whether the state should move toward mandatory unitary combined reporting (MUCR). Readers may recall that this proposal has surfaced on a number of occasions in the past two decades and has in each case been rejected by the Legislature. The task force concluded that there was no interest in enacting MUCR, either by the multistate business community or ADOR.
The task force also studied TCJA’s impact on pass-through entities (PTEs). Although it acknowledged that new IRC section 199A was designed by Congress to provide some level of parity for individual owners of PTEs versus a substantially reduced C corporation tax rate, the task force chose not to recommend conforming with that provision, not only because very few states have done so but because the task force determined it simply wasn’t needed in light of the other proposals.
Finally, the Final Report pondered whether Alabama should follow the lead of at least six other states by enacting either a mandatory or elective PTE tax, in part to reduce the negative impact of the TCJA’s limitation on state and local tax deductions, otherwise known as the “SALT cap.” The Final Report recommends that the Legislature enact an elective PTE tax, whereby the PTE and its owners may elect to pay their Alabama income tax at the entity-level, so that the tax (and the income) would not flow through to the individual owners and then be subject to the $10,000 SALT cap. While the task force studied the Wisconsin PTE act and several others, the Final Report did not recommend a specific model adopted by another state.
The authors expect draft implementing legislation to be issued by the task force in the next few days and that legislation will of course contain much more detail as to all the task force’s proposals. It then becomes a question of whether the Legislature will accept some or all of the task force recommendations during this legislative session, which has 25 meeting days remaining.
If you have any questions regarding the task force’s Final Report or its ramifications, please contact any Alabama member of Bradley’s SALT team.