States Could See Revenue Losses Under Federal Stimulus Bill
Some states could see revenue losses under two provisions of the federal economic relief bill that are designed to help businesses weather the economic downturn.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136), signed into law March 27, will loosen net operating losses and allow businesses to carry back losses for up to five years.
States that conform to the federal definitions of income after NOLs are included will be affected by the change, according to Nicole Kaeding of the National Taxpayers Union Foundation.
“It will hurt state revenue, but from a policy perspective it is the right choice,” Kaeding told Tax Notes. “Expanding NOLs is a key way to mitigate the recession for businesses. If we hadn't expanded NOLs, companies would be faced with large tax bills on income they didn't have. Allowing carrybacks also provides money to businesses quickly.”
Another provision expands the interest deduction cap created by the federal Tax Cuts and Jobs Act.
States using the federal interest cap in their tax bases have received more tax revenue under the TCJA. “Now, they will see part of that clawed back as the cap is loosened,” Kaeding explained.
"Loosening the interest deduction cap also makes sense in a recession. Mechanically, the interest deduction cap became tighter as companies borrowed more to keep their businesses afloat while their income also fell, further tightening the cap," Kaeding said.
Jared Walczak of the Tax Foundation said that although both provisions affect state revenues, they are “also important policy changes to help employers survive the current crisis.”
“Most states will not follow the federal government in allowing net operating losses earned between 2018 through 2020 to be carried back to prior tax years, because states generally disallow net operating loss carrybacks regardless of federal policy, only allowing carryforwards,” Walczak said.
Walczak added that changes to NOL provisions and the net interest deduction were intended to pay down rate reductions under the TCJA, but the changes “did not represent good policy on their own.”
“Corporate income taxes are intended to tax net income, meaning income that is the net of any losses, whenever accrued, and that business expenses, including interest payments, should be taken into account,” Walczak said.
Meanwhile, attorneys at McDermott Will & Emery are warning that the NOL changes could have unintended consequences for businesses, particularly in states that tax global intangible low-taxed income, such as New Jersey. The law firm is part of the State Taxes After Reform (STAR) Partnership, a lobbying effort that encouraged states to decouple from the GILTI provision of the TCJA.
In a March 30 blog post, Alysse McLoughlin and Kathleen Quinn of McDermott said the carryback of NOLs to 2018 and 2019 could reduce deductions under IRC section 250 related to GILTI and foreign-derived intangible income generated in those years.
Noting that New Jersey doesn’t follow the federal NOL rules, McLoughlin and Quinn said that “it does specifically link its GILTI deductions to IRC section 250.”
“Accordingly, the carryback of NOLs at the federal level could result in a reduction of the GILTI deduction that the taxpayer can take for New Jersey [corporation business tax] purposes. As a result, New Jersey could end up taxing far more than 50 percent of a taxpayer’s GILTI,” McLoughlin and Quinn said.
Although most states experienced increased tax revenue collections between July 2019 and February of this year, states are expected to see substantial decreases in tax collections over the next few months because of the COVID-19 pandemic, according to Lucy Dadayan of the Urban-Brookings Tax Policy Center.
Most states are expected to have budget shortfalls for this fiscal year and the next one because of increased spending and declines in revenues, Dadayan said in a March 30 email.