It’s Our Turn: How will State Legislatures Conform (or Not) to Federal Tax Reform?

Even though most of the reforms under the Tax Cuts and Jobs Act are effective for tax years beginning on or after Jan. 1, 2018, failure of states to update their IRC conformity can impact the 2017 tax year.

By Jeff Glickman, SALT partner

Most state legislatures are well into their 2018 regular sessions, and one of the most anticipated issues is how states will conform (or not conform) with federal tax reform under the Tax Cuts and Jobs Act of 2017 (“TCJA”). For purposes of computing state income tax liability (individual or corporate), most states begin with either federal adjusted gross income or federal taxable income, or some variant thereof. Therefore, there are two general conformity principles that states will need to address: (1) Internal Revenue Code (“IRC”) date conformity and (2) specific provision nonconformity.

Generally, for purposes of IRC date conformity, states fall into one of two categories: (1) rolling conformity; or (2) fixed date conformity. Under rolling conformity, states adopt changes to the IRC automatically as they occur. Accordingly, these states, without any state legislative action, have already conformed to IRC changes made by the TCJA. States with fixed-date conformity have statutory provisions that adopt the IRC as of a specific date. Many of these states update their conformity date annually, but not all do. Therefore, for those states to conform to the TCJA, these legislatures will need to enact an update to their IRC conformity date that is at least Dec. 22, 2017.

Even though most of the reforms under the TJCA are effective for tax years beginning on or after Jan. 1, 2018, failure of states to update their IRC conformity can impact the 2017 tax year. For example, on Jan. 12, 2018, Kentucky issued a bulletin explaining its IRC conformity date and the impact on the TCJA. Specifically, the state reminds taxpayers that currently, Kentucky adopts the IRC as in effect on Dec. 31, 2015. Therefore, not only has Kentucky not yet adopted the TCJA changes that are effective in 2018, it has not yet adopted the TCJA changes that are effective in 2017, such as:

• Medical Expenses – The itemized deduction for medical expenses is limited by 7.5 percent of adjusted gross income for federal purposes, but the Kentucky limitation is 10 percent based on federal law as of Dec. 31, 2015.
• Disaster Relief Provisions – Several federal changes to provide tax relief for natural disasters in 2016 and 2017 are not included in Kentucky law. These provisions affect retirement plan distributions and casualty loss deductions.
• Depreciation Differences – New accelerated depreciation benefits effective after Sept. 27, 2017, are not applicable to Kentucky.
• Energy Efficient HVAC Property – Energy efficient heating and air-conditioning property placed in service after Nov. 2, 2017, is now eligible to be expensed under IRC Section 179. This does not apply to Kentucky.

On the other hand, West Virginia has already updated its IRC conformity date from Dec. 31, 2016, to Dec. 31, 2017, for both corporate and individual income tax purposes.[1] Those bills provide that all amendments made to the IRC between Jan. 1, 2017, and Dec. 31, 2017 are to be given effect for Kentucky tax purposes regardless of whether such amendments are applied retroactively or prospectively. Therefore, West Virginia has generally adopted the provisions of the TCJA.

Specific provision nonconformity is a common practice among states that generally adopt the IRC (whether on a rolling basis or through fixed date conformity) but don’t want to adopt all IRC provisions. For example, West Virginia allows resident individual taxpayers a personal exemption amount of $2,000 for “each exemption for which he is entitled to a deduction for the taxable year for federal tax purposes.”[2] By updating its fixed date conformity and adopting the provisions of the TCJA, West Virginia eliminated its personal exemption beginning in 2018 because no individual would have been entitled to a personal exemption deduction for federal tax purposes. However, the state did not want to eliminate its personal exemption, so the same bill that updated the IRC conformity date also added a provision that makes clear that the state personal exemption is allowed for tax years beginning in 2018 based on the number of personal exemptions the taxpayer would have been entitled to had federal law not eliminated them. Other common examples of IRC provisions that states have not conformed to in the past are bonus depreciation and increased expense limits under Section 179.

It will be interesting to see how states decide to conform or not to conform to the TCJA. As summarized in this article, state conformity decision not only impact tax planning for 2018, but may also impact tax liability for 2017. Aprio’s SALT team is monitoring these developments to help businesses understand their state income tax exposure, and we will include any significant updates in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the February 2018 SALT Newsletter. 

[1] H.B. 4135 (corporate) and H.B 4146 (individual), effective February 9, 2018.

[2] W.V. Code § 11-21-16(a).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.