COST Weighs-In on Alabama DOR’s Analysis of Federal Tax Reform - SALT Alert: Alabama Edition

by Bradley Arant Boult Cummings LLP
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On July 31, the Alabama Department of Revenue (ADOR or Department) released its long-awaited and quite comprehensive analysis of the impact of the Tax Cuts and Jobs Act of 2017 (otherwise known as “federal tax reform”) on both the Alabama income tax and financial institution excise tax. The Department sought input from tax practitioners and the business community and much of that input was reflected in the final version of its report, although the Department warns that the report is still a work in progress.

The influential Council On State Taxation (COST) in Washington, DC submitted its comment letter on August 28 to the Acting Director of the ADOR’s Tax Policy and Governmental Affairs Division, Kelley Gillikin, and to Deputy Commissioner of Revenue Joe Garrett. Like their comment letter submitted in response to a previous draft of the report, COST focused on three issues:  Alabama’s conformity with new IRC §965 on deemed repatriation income; the new interest expense limitation under IRC §163(j) and its interrelationship with Alabama’s add-back statute; and Alabama’s taxation of Global Intangible Low-Taxed Income (GILTI) under new IRC §951A.

COST, through its research affiliate, the State Tax Research Institute, and Ernst & Young LLP released a study in March that has become the benchmark analysis in this rapidly evolving area. That study projected an automatic 11-12% increase in Alabama corporate income tax revenue, which could amount to a $60-70 million windfall to the Education Trust Fund annually, based on current upward trends.

Section 965 deemed repatriation income ‒ In its earlier comment letter, COST acknowledged that the ADOR was likely correct in assuming that IRC §965 income would also be taxable by Alabama, subject to Alabama’s separate corporate dividends received deduction.  In the new comment letter, however, COST didn’t elaborate on the constitutional issues involved when a recipient of Section 965 income can’t claim the Alabama DRD, such as a less than 20% corporate shareholder or a partnership, S corporation, or individual taxpayer. COST urged the Department to promptly issue proposed regulations, following up on several helpful notices posted on its website.

Should Alabama de-couple from Section 163(j)? ‒ COST agreed with the ADOR’s conclusion that Alabama conforms to the new IRC §163(j) limitation on interest expense deductions, but pointed out a few potential ambiguities or errors in the Department’s analysis of how that new limitation will work:

“[T]he Department’s example makes no reference to the calculation of the federal limitation, whether there is a separate state calculation of the limitation for Alabama corporate taxpayers, and whether and how the limitation is assigned to each separate taxpayer.  Moreover, the guidance does not provide a statutory basis or analysis for why the I.R.C. §163(j) limitation should be applied before the add-back statute, or why the adverse impact of the add-back statute should be made worse by applying the I.R.C. §163(j) limitation to the same interest payments, potentially frustrating the Alabama Legislature’s intent in providing add-back exceptions allowing full deductibility of certain interest expenses.”

COST pointed out that the Department’s proposed ordering rule “can cause double taxation by double disallowance of interest deductions and punishes legitimate and common forms of intercompany borrowing.” COST recommended that the ordering of the Section 163(j) limitation and the add-back statute be reversed to “at least mitigate that risk.”

On a more global basis, COST recommended that the Alabama Legislature be briefed on the policy concerns with conforming to Section 163(j), pointing out recent de-coupling legislation enacted in several states, including Georgia, Tennessee, and, potentially, Florida. Mississippi does not otherwise conform to this provision due to its separate allowance of interest expense deductions. COST projected that “Alabama could be alone among its neighbors in implementing this provision, which does not advance an Alabama policy objective and is out of sync with the objective at the federal level to not impact domestic financing…,” pointing out that interest on intercompany loans within a federal consolidated group is eliminated from the calculation. There could be a potential effort to decouple Alabama law from Section 163(j).

GILTI—what is it? – COST was not so certain regarding the Department’s conclusion that Alabama law automatically incorporates IRC §951A. The comment letter also points out that several states have announced they are treating GILTI in the same way as foreign dividends, “fully or mostly exempting the GILTI income because of the state foreign dividends received deduction.” COST believes this treatment “would not only be consistent with Alabama’s historic approach to foreign income taxation, it would avoid the complexities and challenges noted below.”

COST restated its concerns that including GILTI in Alabama taxable income violates the Foreign Commerce Clause under Kraft General Foods, Inc. v. Iowa Department of Revenue and Finance, 505 U.S. 71 (1992), and its progeny. The comment letter argues this may be a “permissible goal for the federal government, but states are limited by constitutional provisions such as the Commerce Clause and Foreign Commerce Clause that make it impermissible to favor domestic commerce over foreign commerce.” COST again urged the Department to inform both the Alabama Legislature and Governor Ivey of these risks, while arguing that Alabama conformity with GILTI could also be harmful from a state tax policy prospective:

“state corporate income tax laws in Alabama and in other states do not allow for foreign tax credits, and therefore all of the GILTI income, from low- and high – tax countries, would be subject to state corporate income tax.  This would constitute a vast and unprecedented expansion of the Alabama state corporate income tax base...”

The comment letter mentions 12 states have so far decoupled from taxation of GILTI and predicts more are likely to follow:  Georgia, Kentucky, North Carolina, Indiana, Connecticut, Michigan, Wisconsin, North Dakota and Hawaii. South Carolina and two other states don’t include GILTI in their corporate income tax base due to existing decoupling from the Internal Revenue Code. 

COST did, however, agree with the Department’s conclusion that if taxing GILTI income will be pursued, at least the new IRC §250 deduction would mitigate the Alabama tax hit. The comment letter urges the Department to “caution state legislators on the constitutional infirmities (and policy drawbacks) associated with taxing GILTI income” if it concludes that it cannot apply foreign dividend treatment to GILTI.

During his remarks at the annual meeting of the Alabama State Bar Tax Section in Montgomery on August 29, Deputy Commissioner of Revenue Joe Garrett acknowledged receipt of the COST comment letter and urged tax practitioners and other business organizations to also inform the Department of their views. Deputy Commissioner Garrett also pointed out several uncertainties regarding federal tax reform and the state’s antiquated financial institution excise tax. There is a separate working group including members of the Alabama Bankers Association, their tax advisers, and the ADOR that is studying these issues.

The 2019 regular session, which does not begin until March 5, will be a busy one for tax-related legislation.  If readers have any questions regarding the Department’s report, they should contact Kelley Gillikin or Joe Garrett at the ADOR, Karl Frieden or Ferdinand Hogroian at COST, or any Alabama member of Bradley’s SALT Practice Team listed below. Three members of the SALT Practice Team were asked to serve on one or both of the ADOR’s income tax and FIET working groups.

Upcoming Seminars/Speeches by Bradley SALT Practice Team Members:

ABA Tax Section Joint Fall Meeting, Atlanta, Georgia, October 4-6, 2018.—Bruce Ely is serving on a panel discussing the various state responses to the TCJA’s $10,000 SALT deduction limitation and the recently-issued IRS proposed regulations intended to stop these so-called “SALT cap workarounds.” Bruce Ely is also moderating a panel on the states’ responses to the new federal partnership audit rules, highlighting the model statute being advocated by COST, AICPA, TEI, the ABA SALT Committee, IPT and others to the Multistate Tax Commission and the states. Will Thistle is speaking to the SALT Committee’s Executive Committee on recent pass-through entity developments.

Annual Paul J. Hartman/Vanderbilt University SALT Forum, Nashville, Tennessee, October 17-19, 2018.—Bruce Ely is serving on a panel discussing recent developments in the state taxation of pass-through entities while Chris Grissom is speaking on Alabama recent tax developments.

Council On State Taxation (COST) Annual Meeting, Phoenix, Arizona, October 23-26, 2018.—Chris Grissom will be speaking on ‘Best Practices for Credits & Incentives Management and How to Prepare for FASB Topic 832 and New IRC 118.’ Bruce Ely will be serving on a panel discussing recent developments in the state taxation of pass-through entities with a focus on the model partnership audit statute being advocated to the MTC and states by COST, AICPA, TEI, ABA SALT Committee and IPT.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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