Small Business Act Increases I.R.C. Decoupling Concerns
By Dolores W. Gregory and Steven Roll
Publication Date: 10/14/2010
The prospect of another round of state decoupling from recently enacted federal tax breaks feeds a growing concern about the apparent indifference of federal policymakers to state fiscal problems, several state tax specialists told BNA.
“Every time the federal government acts to expand or contract the tax base, the states must react by increasing their tax rates or decoupling from the federal provisions,” said Walter Hellerstein, professor of law with the University of Georgia. “It's a messy complicated process. There's something dysfunctional about the lack of coordination.”
The recent enactment of H.R. 5297, the Small Business Jobs and Credit Act of 2010 (Pub. L. No. 111-240), which includes an extension of 50 percent bonus depreciation and an increase in Internal Revenue Code Section 179 expensing limitations, leaves states with “two bad choices,” Hellerstein said. States can either “adopt bonus depreciation and face acute budget problems or … decouple and contribute to complexity and difficulty in administration.”
“As we talk with state legislators and state tax administrators, we're finding a growing sense—part of it may be frustration—that there is a disconnect between the federal government and the states in recognizing the fiscal interrelationships they have,” said Harley Duncan, a managing director in the State & Local Tax practice of KPMG LLP.
“The legislators will say ‘we've been trying to cope with budget shortfalls and trying to balance the budget for three years now, and we have a couple more years to go, and still we keep getting one federal enactment after another that detracts from our revenue base,' ” Duncan said.
Said Hellerstein, “This lack of fiscal coordination is another example of the breakdown of civility in government. There's an increasing indifference at the federal level to the likely consequences that tax policies will have on states.”
Tax Breaks for Small Business
The Small Business Jobs and Credit Act, enacted Sept. 27, also includes a temporary exclusion of the gain on certain small business stock, a temporary reduction in the recognition period for built-in gains tax, and an increase in the amount allowed as a deduction for start-up expenditures in 2010.
Because many states base their income taxes on federal taxable income, these changes have implications for state revenues. A reduced federal base translates into a shrunken base for states, most of which have been grappling with severe budget shortfalls for several years and can ill afford to absorb even a minor revenue loss.
Whether a state decouples sometimes depends on how it conforms to the Internal Revenue Code. About half the states automatically conform. The others conform to the I.R.C. as of a specific date.
The states that automatically conform must adopt legislation in order to decouple from specific I.R.C. provisions. The others can decouple from certain provisions by changing the date of overall conformity—or in some cases, by declining to change the date of conformity. New Hampshire, for example, conforms to the version of the I.R.C. in effect on Dec. 31, 2000.
Not a New Development
The pressure on states to decouple from federal efforts to stimulate the economy is not a new development. The Job Creation and Worker Assistance Act of 2002 (Pub. L. No. 107-147)—enacted during a recession—provided an additional first-year depreciation to encourage investment. Ultimately, about 30 states decoupled from the provision.
States have since decoupled from various other provisions—including bonus depreciation provisions that apply to the 2008 and 2009 tax years, federal net operating loss provisions, and federal treatment of cancellation of indebtedness income. In fact, the Center on Budget and Policy Priorities (CBPP) has urged decoupling in the past as a means of generating revenue. In 2008 the CBPP issued a paper suggesting that states could recoup some $470 million in lost revenues if they decoupled from IRC Section 199, the federal domestic production deduction.
The new act, among other things, extends the applicability of bonus depreciations provisions under IRC Section 168(k) for one year and expands enhanced expensing rules under IRC Section 179. All but about a dozen states that impose income tax have already decoupled from federal bonus depreciation provisions. Nearly half the states have opted against following the federal enhanced expensing rules.
For taxpayers, the prospects of further state decoupling from the I.R.C. means not only the loss of a tax benefit at the state level but the additional cost of compliance, according to Karen Syrylo, state taxation consultant with the Maryland Chamber of Commerce.
“A state like Maryland has already decoupled from many of the [federal] provisions on a permanent basis, and then on an item-by-item basis,” Syrylo said.
“Maryland's form for decoupling has grown—it's much larger than it used to be—and it gets even more complicated with so many companies having net operating losses. You have to track not only your own NOL carryforward, but the addition and subtraction modifications from that year.”
For additional information on how each state is handling bonus depreciation, read State Conformity with Federal Depreciation Rules »
The complete text of this article can be found in the BNA Daily Tax Report, October 14, 2010. For comprehensive coverage of taxation, pension, budget, and accounting issues, sign up for a free trial or subscribe to the BNA Daily Tax Report today. Learn more »
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