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US Treasury Issues Guidance on the ARPA Claw-Back Provision

Earlier this week, the US Department of the Treasury (Treasury) issued formal guidance regarding the administration of the American Rescue Plan Act of 2021 (ARPA) claw-back provision. The guidance (Interim Final Rule) provides that the claw-back provision is triggered when there is a reduction in net tax revenue caused by changes in law, regulation or interpretation, and the state cannot identify sufficient funds from sources other than federal relief funds to offset the reduction in net tax revenue. The Interim Final Rule recognizes three sources of funds that may offset a net tax revenue reduction other than federal relief funds—organic growth, increases in revenue (e.g., a tax rate increase) and certain spending cuts (i.e., cuts that are not in an area where the recipient government has spent federal relief funds). According to the Treasury, this framework recognizes that money is fungible and “prevents efforts to use Fiscal Recovery Funds to indirectly offset reductions in net tax revenue.”

The Interim Final Rule also provides guidance on what is considered a change in law, regulation or interpretation that could trigger the claw-back (called covered changes), but that point remains somewhat ambiguous. The Rule provides that:

The offset provision is triggered by a reduction in net tax revenue resulting from ‘a change in law, regulation, or administrative interpretation.’ A covered change includes any final legislative or regulatory action, a new or changed administrative interpretation, and the phase-in or taking effect of any statute or rule where the phase-in or taking effect was not prescribed prior to the start of the covered period. [The covered period is March 3, 2021 through December 31, 2024.] Changed administrative interpretations would not include corrections to replace prior inaccurate interpretations; such corrections would instead be treated as changes implementing legislation enacted or regulations issued prior to the covered period; the operative change in those circumstances is the underlying legislation or regulation that occurred prior to the covered period. Moreover, only the changes within the control of the State or territory are considered covered changes. Covered changes do not include a change in rate that is triggered automatically and based on statutory or regulatory criteria in effect prior to the covered period. For example, a state law that sets its earned income tax credit (EITC) at a fixed percentage of the Federal EITC will see its EITC payments automatically increase—and thus its tax revenue reduced—because of the Federal government’s expansion of the EITC in the ARPA. This would not be considered a covered change. In addition, the offset provision applies only to actions for which the change in policy occurs during the covered period; it excludes regulations or other actions that implement a change or law substantively enacted prior to March 3, 2021. Finally, Treasury has determined and previously announced that income tax changes—even those made during the covered period—that simply conform with recent changes in Federal law (including those to conform to recent changes in Federal taxation of unemployment insurance benefits and taxation of loan [...]

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The US Department of the Treasury Says State IRC Conformity Bills Do Not Trigger Federal Relief Claw-Back Provision

As we’ve blogged about in the past, the recently enacted American Rescue Plan Act of 2021 (ARPA) includes an ambiguous claw-back provision. If broadly interpreted, it could result in states losing relief funding provided under the APRA if there is any state legislative or administrative change that results in the reduction of state revenue. This provision is causing havoc in the state tax world, rightfully so.

After much yelling and screaming from state attorneys general and those in the tax world, including McDermott (see McDermott letter to Treasury Secretary Janet Yellen attached), the US Department of the Treasury issued a press release announcing forthcoming “comprehensive guidance” on this provision. Treasury also addressed a question that has been on the top of our minds since the provision was enacted: Could state legislation addressing state conformity to the Internal Revenue Code trigger the claw-back? States routinely conform to and decouple from changes to the Internal Revenue Code, so if such actions could trigger the claw-back, state legislatures would be reluctant to consider them. We were so concerned about this issue that we specifically addressed it in our letter to Secretary Yellen.

This week, we received the Treasury’s guidance on this issue: Conformity bills will not trigger the claw-back. In its press release, Treasury stated:

… Treasury has decided to address a question that has arisen frequently: whether income tax changes that simply conform a State or territory’s tax law with recent changes in federal income tax law are subject to the offset provision of section 602(c)(2)(A) of the Social Security Act, as added by the American Rescue Plan Act of 2021. Regardless of the particular method of conformity and the effect on net tax revenue, Treasury views such changes as permissible under the offset provision.

This is a step in the right direction and should ease concerns of state legislatures. Passing a conformity bill will not cause any loss of federal funding. Treasury’s guidance, because it applies to all “methods of conformity,” should cover any legislation that either couples with or decouples from the Internal Revenue Code.

But our work is not done. In our letter to Secretary Yellen we also asked for guidance confirming that state actions in other areas will not trigger the claw-back. Specifically, we made concrete suggestions that actions to correcting tax statutes or rules that are either unconstitutional or barred by or violate federal law also should not trigger the claw-back. Treasury’s recent press release gives us a glimmer of hope that Treasury will exclude such actions from the clutches of the claw-back provision as well. Stay tuned for more!




Overview of Minnesota’s Response to Federal Tax Reform

Minnesota has several bills pending that would address the Minnesota state tax implications of various provisions of the federal tax reform legislation (commonly referred to as the Tax Cuts and Jobs Act).

HF 2942

HF 2942 was introduced in the House on February 22, 2018. This bill would provide conformity to the Internal Revenue Code (IRC) as of December 31, 2017, including for corporate taxpayers. The bill makes clear that, with respect to the computation of Minnesota net income, the conformity to the Internal Revenue Code as amended through December 31, 2017, would be effective retroactively such that the federal provisions providing for the deemed repatriation of foreign earnings could have implications in Minnesota. (more…)




Southeast States Respond to Federal Tax Reform and NJ Senate Leader Talks Tax Surcharge to Limit Corporate “Windfall”

Virginia and Georgia are two of the latest states to pass laws responding to the federal tax reform passed in December 2017, known as the Tax Cuts and Jobs Act (TCJA). Both states updated their codes to conform to the current Internal Revenue Code (IRC) with some notable exceptions.

Virginia

On February 22, 2018, and February 23, 2018, the Virginia General Assembly enacted Chapter 14 (SB 230) and Chapter 15 (HB 154) of the 2018 Session Virginia Acts of Assembly, respectively. Before this legislation was enacted, the Virginia Code conformed to the IRC in effect as of December 31, 2016. While the new legislation conforms the Virginia Code to the IRC effective as of February 9, 2018, there are some very notable exceptions. The legislation explicitly provides that the Virginia Code does not conform to most provisions of the TCJA with an exception for “any… provision of the [TCJA] that affects the computation of federal adjusted gross income of individuals or federal taxable income of corporations for taxable years beginning after December 31, 2016 and before January 1, 2018…” Thus, despite Virginia’s update of its IRC conformity date, Virginia largely decouples from the TCJA. (more…)




Illinois Responds to Federal Tax Reform Bill by Proposing Legislation to Decouple from the FDII Deduction

The 2017 federal tax reform bill, known as the Tax Cuts and Jobs Act (Act), made a number of significant changes to the law, particularly to the international tax provisions of the Internal Revenue Code (IRC). Last month, Illinois joined the growing number of states responding to the Act by proposing legislation purporting to add-back the new federal deduction for foreign-derived intangible income (FDII). The FDII deduction, enacted in sub-part (a)(1)(A) of new IRC section 250, allows US corporate taxpayers a deduction in the amount of 37.5 percent of income earned from the sale of property to a person outside of the US for use outside of the US or the provision of services to a person outside of the US or with respect to property not located in the US. (For tax years beginning 2026, the deduction is reduced to 21.875 percent.)

Senate Bill (SB) 3152 (linked here) proposes an amendment to Section 203(b)(2) of the Illinois Income Tax Act (IITA) that would add back to taxable income the amount of a corporate taxpayer’s FDII deduction allowed under the IRC. Absent this amendment, the FDII deduction likely automatically would be included in Illinois’ corporate tax base: Illinois is a “rolling” conformity state (IITA section 1501(a)(11)), and the FDII deduction is a “special deduction” under the IRC which is incorporated in Illinois’ starting point for taxable income (IITA section 203(b)(1), (e) (For corporations IITA imposed on “taxable income” as defined under the IRC); IRC section 63 (“taxable income” includes “special deductions”)).

SB 3152 has been assigned to the Senate Revenue committee for review. It remains to be seen how, if at all, Illinois will respond to other changes enacted by the federal Act, particularly with respect to the other new international tax provisions, including those related to the deferred foreign earnings transition tax and global intangible low-taxed income, which include both additions and deductions at the federal level.




Governor Cuomo’s Amended Budget Bill Would Address the Deemed Repatriation Dividend Provisions

New York is the latest state to address certain state tax implications of the 2017 federal tax reform bill, the Tax Cuts and Jobs Act. Governor Andrew Cuomo’s 30-day amendments to the Governor’s Budget Bill were released on February 15 and one piece of the amended Bill explicitly addresses the foreign-earnings, deemed federal repatriation provisions in the new section 965 of the Internal Revenue Code (IRC).

Even before the release of the 30-day amendments, we expected the amount of foreign earnings deemed repatriated and brought into the federal income tax base under IRC § 965 would be considered “other exempt income” under the New York Tax Law and, thus, not subject to tax in New York as long as received from a unitary subsidiary. However, the Governor’s 30-day amendments make it clear that any amount included in the federal tax base under the repatriation transition provisions would be excludable from income, even if such amounts were received from a non-unitary subsidiary. This proposed exclusion for amounts deemed received from non-unitary subsidiaries is an expansion of New York’s usual policy. This expansion, however, would apply only with respect to the deemed repatriation of foreign earnings under IRC § 965.

The 30-day amendments also would make clear the federal deduction permitted under IRC § 965(c) (which facilitates a reduction of the effective federal tax rate on the deemed repatriated foreign earnings) would not be allowed in computing New York taxable income. We expected New York would make this proposed change because disallowing the § 965(c) deduction from New York taxable income would be consistent with excluding the deemed repatriation from taxable income.

Unlike other states, i.e., Connecticut, the Governor’s Bill does not address the amount of expenses attributable to the amount deemed repatriated under IRC § 965 and includable in the New York tax base. The Governor’s Bill would, however, provide that no penalties would be imposed for any failure to make sufficient estimated payments if the short-fall in payments is due to the increase in tax resulting from the inability to deduct such expenses from taxable income.

Please reach out to us with any questions about New York’s proposed treatment of the federal repatriation provisions or other questions about the potential law changes in New York.




Connecticut Responds to the Federal Repatriation Tax

Earlier this month, Connecticut Governor Dan Malloy released his Governor’s Bill addressing the various state tax implications of the federal tax reform bill enacted by Congress in December 2017, commonly referred to as the “Tax Cuts and Jobs Act.” Among other things, the Governor’s Bill addresses Connecticut’s treatment of the foreign earning deemed repatriation tax provisions of amended section 965 of the Internal Revenue Code (IRC). While the Governor’s Bill does not explicitly provide that the addition to federal income under IRC section 965 is an actual dividend for purposes of Connecticut’s dividend received deduction, the bill does protect Connecticut’s ability to tax at least part of the income brought into the federal tax base under the federal deemed repatriation tax provisions by defining nondeductible “expenses related to dividends” as 10 percent of the amount of the dividend. (more…)




SALT Implications of the House and Senate Tax Reform Bill

Many provisions of the House and Senate tax reform proposals would affect state and local tax regimes. SALT practitioners should monitor the progress of this legislation and consider contacting their state tax administrators and legislative bodies to voice their opinions.

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SALT Implications of Proposed Section 385 Debt/Equity Regulations

On April 4, 2016, without warning, the US Department of the Treasury proposed a new set of comprehensive regulations under section 385. There had been no advance indication that regulations were even under consideration. Although the Treasury indicated that the proposed regulations were issued in the context of addressing corporate inversions, their application went well beyond the inversion space and they apply to inter-corporate debt regardless of whether it occurs in an international context. The following is a discussion of the state and local tax consequences of the proposed regulations; for a detailed discussion of the proposed regulations themselves, see this previous article.

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