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States Could Revisit GILTI to Shore Up Revenue

Posted on June 23, 2020

As states grapple with the economic fallout from the COVID-19 pandemic, some could revisit their treatment of global intangible low-taxed income to generate much-needed revenue.

The Tax Cuts and Jobs Act shifted business taxation from a worldwide system to a quasi-territorial system to deter profit shifting by U.S. multinational corporations. In doing so, the law established GILTI, a type of income earned by foreign affiliates of U.S. multinational companies from intangible assets.

“I wouldn’t be surprised if states look to their treatment of GILTI as a mechanism or an opportunity . . . to tax GILTI or a larger portion of GILTI,” Todd Betor of Eversheds Sutherland (US) LLP told Tax Notes June 2.

The Tax Foundation and other pro-business groups have argued that states should not conform to the GILTI provision of the TCJA because it raises constitutional questions that could lead to litigation and may also deter large employers from locating facilities in their state.

“States face serious budget gaps that they will need to fill, but that will not happen without economic recovery, and states that go too far in trying to tax activity taking place outside their state risk losing some of the in-state activity as well,” said Jared Walczak, director of state tax policy at the Tax Foundation.

Proponents of taxing GILTI argue that it would be constitutional and have suggested that if states need to increase taxes to address budget gaps from the pandemic, they would be better off raising them on profitable corporations. 

Darien Shanske, professor of law at the University of California, Daviswrote April 6 in Tax Notes State that “when the time comes, states should still broaden their corporate tax bases and conform to [GILTI].”

“The millions raised in GILTI conformity can go directly into the pockets of those who need it most, can use the money to stay home when they are not feeling well, and will spend it quickest,” Shanske wrote.

As of January 1, 24 states tax or could tax GILTI in some form, according to the Tax Foundation. Some states theoretically conform to GILTI but haven't issued guidance to that effect and aren't actively collecting the tax, Walczak said.

Some states that adopt changes to the Internal Revenue Code on a rolling basis considered legislation this year to decouple from GILTI, including Alabama, Iowa, Nebraska, and Utah. But observers say the public health crisis has likely put a hold on the decoupling legislation for now.

Jamie Yesnowitz, state and local tax practice and national tax office leader at Grant Thornton LLP, said he expects states will first look to decouple from some provisions of the Coronavirus Aid, Relief, and Economic Security (CARES) Act before revisiting their treatment of GILTI. However, he said, “My sense is that doing something like reevaluating GILTI is a little bit more likely than simply raising tax rates. It is a way to raise revenue in a manner that is less onerous than imposing a tax rate increase on everybody.” 

In Alabama, lawmakers considered tax reform bill S.B. 250, which would have decoupled from GILTI and addressed other changes under the TCJA. Sen. Dan Roberts (R), the bill's sponsor, told Tax Notes that legislators were hindered by the shortened session caused by the pandemic.

Lawmakers in the state returned in early May to wrap up the legislative session. Before adjourning, the Senate Finance and Taxation Education Committee proposed a substitute for the bill that would have excluded federal tax credits and other business tax relief under the CARES Act from state income tax. The provision decoupling from GILTI — and other provisions addressing the TCJA — would have been removed under that proposal.

However, Roberts said, “We will have S.B. 250 and H.B. 353 ready to go [in] the next session. All the items including GILTI will be included in the bills. These are critical issues and need to be addressed."

Morgan Scarboro, an economist and tax policy manager at MultiState Associates, said that once states understand the magnitude of their revenue challenges, they will try to come up with creative ways to meet them.

“We're researching state responses to earlier recessions, and one preliminary finding is that states generally don't react immediately; most major tax changes are enacted a year or so following the onset of the recession,” Scarboro said.

MultiState Associates is part of the STAR (State Taxes After Reform) Partnership, which lobbied states to decouple from GILTI. Scarboro said she expects some states will consider their treatment of GILTI, although she doesn’t think they will ultimately change their treatment to conform to GILTI.

“States understand that conforming to GILTI presents significant legal challenges that could involve costly litigation. States also understand that conforming to GILTI presents significant economic and administrative challenges that could lead to taxpayers leaving the state, something states can't afford right now,” Scarboro said.

Scarboro said most states that are not currently taxing foreign income would have to do so legislatively. Others say tax treatment of GILTI could be implemented through regulatory guidance, although it could open states up to litigation.

Betor said New York is a prime example of how easily states can change their treatment of GILTI. Last year, the state adopted legislation exempting 95 percent of GILTI for tax years beginning on or after January 1, 2019. Before the legislation, the state taxed 50 percent of GILTI and provided a section 250 deduction, along with factor relief and a net inclusion, Betor said. 

“It shows how easily a state can toggle between taxing 50 percent and then taxing less,” Betor said. “Not to say that a state couldn’t go the opposite and tax more then.”

Regarding states with rolling conformity in which tax professionals rely on regulatory guidance, Betor said he wouldn't be surprised if the revenue departments were to change their position.

“There could be some regulatory guidance . . . where it’s just as simple as the department interpreting the [dividends received deduction] to apply one way,” Betor said.

Sebastian Watt of Reed Smith LLP said that although states could change their treatment of GILTI through regulatory guidance, he would hope that revenue departments would focus instead on efficient administration.

“If the goal is to increase revenue, I would hope it would be done legislatively,” Watt said. 

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