Many states, like Florida, adopt or “piggyback” the Internal Revenue Code as the starting point for calculating their state corporate income tax, subject to certain modifications. The Florida Legislature’s adoption of the Internal Revenue Code in effect on January 1, 2018, which includes the Tax Cuts and Jobs Act, has potentially broad ramifications for Florida corporate income taxpayers. This article supplements our prior posts (Florida Department of Revenue Conducts First Public Meeting Regarding TCJA Changes and Florida DOR Seeks Input for TCJA Impact Analysis) on the Department of Revenue’s study of the TCJA’s impact on the Florida corporate income tax, and it summarizes the 13 provisions that are currently the focus of that analysis.
Net interest deduction limitation – IRC Section 163(j)
Historically, interest on a business or investment related debt was, in most instances, a deductible expense of the borrower. However, the TCJA created a new interest expense deductibility limitation under § 163(j) for deductions for business interest expenses. In general, this section now applies to all business entities and limits a taxpayer’s interest expense deductions for a taxable year to the sum of 30% of adjusted taxable income plus the amount of any business interest. For purposes of the new limitation, “adjusted taxable income” is determined in a manner similar to earnings before interest, tax, depreciation and amortization (EBIDTA) for tax years prior to January 1, 2022 and similar to earnings before interest and tax (EBIT) for tax years on or after January 1, 2022. Thus, for tax years 2022 and later, the narrower definition will generally result in a smaller business interest deduction.
Regardless, the new deduction limitation to § 163(j) will result in an increase of federal taxable income and more Florida Corporate Income Taxes paid. An analysis commissioned by the Council on State Taxation (COST) suggests this limitation would increase the federal corporate tax based by 6.4%. Such an increase would result in a $143M+ tax increase on Florida’s corporations in 2018-2019. This tax increase would be recurring and is projected to grow to more than $220M per year after the definition of adjusted taxable income changes in 2022.
Many in Congress have suggested this new interest limitation was intertwined with the additional bonus depreciation benefits for taxpayers contained in the TCJA. However, when states, like Florida, already decouple from federal bonus depreciation the scale shifts disproportionately to burden Florida corporations making investments. Therefore, the Florida Legislature should decouple from the interest limitation in § 163(j). Other states including Georgia, Tennessee, Connecticut, Indiana, and Wisconsin have already chosen to decouple from the federal interest limitation. Florida should retroactively decouple from the TCJA changes to § 163(j).
Net Operating Losses – IRC Section 172
A Net Operating Loss (NOL) occurs when a taxpayer’s business deductions exceed gross income in a tax year. Prior to the TCJA, an NOL generally was required to be carried back to the two preceding tax years, with any excess NOL then carried forward over to the 20 succeeding tax years. For regular federal tax purposes, the NOL was eligible to offset up to 100% of the taxable income of a tax year within the carryback and carryforward periods. For Florida purposes, NOLs are not able to be carried back, but are eligible to offset up to 100% of the taxable income for the carryforward period.
The changes made by the TCJA limit the use of NOLs. For NOLs arising in tax years beginning after December 31, 2017, the TCJA limits the NOL deduction to 80% of taxable income. Additionally, the TCJA eliminated the two-year carryback period for new NOLs, but allows NOLs to be carried forward indefinitely.
The 80% limitation will require taxpayers to pay tax on at least 20% of its income regardless of the fact that the business’s deductions exceed gross income. For example, if at the end of a year a business has an after-tax income of $100,000, even if it has a NOL of $200,000, the NOL will be limited to 80% of the $100,000 resulting in $20,000 of taxable income. The Florida Legislature should consider decoupling from the 80% NOL limitation included in the TCJA.
Research & Experimentation Expenditures – IRC Section 174
Historically, Florida strongly encourages corporations to invest in research & development in the State. See Section 220.196, Florida Statutes, which was initially enacted in 2011 and expanded in recent years. Florida’s research & development credit applies to new expenses eligible for the federal research & development credit in § 41 of the Internal Revenue Code.
While the TCJA did not change the federal credit for new research & development activities, the Act resulted in significant changes to the research & experimentation deduction contained in IRC § 174. Currently, taxpayers have an option of how to treat research & experimentation expenditures under § 174 – direct expensing of expenditures when paid or incurred, or capitalization and amortization over no less than sixty months from when the taxpayer first begins to derive benefit from the research & experimentation. Under the TCJA, taxpayers will have far fewer options and far less flexibility in treating these expenditures. For tax years beginning after Dec. 31, 2021, taxpayers must capitalize and amortize all research & experimentation expenditures paid or incurred in connection with their trade or business. The straight-line recovery periods are five years and fifteen years for domestic and foreign incurred expenditures, respectively.
If the Florida Legislature wants to continue to encourage research & experimentation in the State, it may choose to reinstate the option for corporations to directly expense such expenses when paid or incurred.
Treatment of one-time deemed repatriated foreign income – IRC Section 965
Section 965 imposes a one-time transition tax on a U.S. shareholder’s post-1986 previously untaxed accumulated foreign earnings and profits generated from its investment in a specified foreign corporation. These earnings are deemed to be “repatriated” on a pro rata basis to U.S. shareholders owning at least a 10% interest in the foreign entity, and are reportable in the foreign entity’s last tax year beginning before January 1, 2018. Different effective tax rates for cash and cash equivalents and non-cash amounts, both lower than the standard federal corporate rate, are achieved through certain deductions.
Section 965 income and deductions are reported to the IRS on a separate transition tax statement attached to the federal return, with only the resultant tax liability reported on Schedule J and, consequently, included on line 31 of the federal return. Based on guidance from the IRS regarding these reporting mechanics, the Department previously issued informal guidance that deemed repatriation income under IRC §965 is not generally included in the Florida corporate income tax base. TIP 18C01-01 (April 27, 2018), available at: https://revenuelaw.floridarevenue.com/LawLibraryDocuments/2018/04/TIP-121710_TIP%2018C01-01%20FINAL%20RLL.pdf.
The Legislature should codify the Department’s informal pronouncement, in the interests of clarity and certainty for both the Department and taxpayers. Unless the Legislature reverses course and requires an addition of deemed repatriated foreign income to the Florida tax base, these amounts should be excluded from Florida corporate income tax for most taxpayers.
Repeal of the Alternative Minimum Tax – IRC Sections 53, 55 and 56
The federal corporate AMT is repealed for taxable years beginning after December 31, 2017. Any existing federal AMT credits earned from previously paid AMT may be used to offset regular federal corporate tax liability, and are partially refundable for any tax year beginning after December 31, 2017 and before January 1, 2022 in an amount equal to 50% of the excess of the AMT credit for the taxable year over the amount of credit allowable for the year against regular tax liability. In tax year 2021, any remaining AMT credit will be refundable.
The Florida AMT is imposed under Section 220.186, Florida Statutes, only on a taxpayer liable for the federal AMT. Since the federal AMT is repealed for tax years beginning after December 31, 2017, Florida corporate income taxpayers will no longer be subject to Florida AMT. Unless the Legislature specifically adopts a new Florida AMT independent of the now-repealed federal AMT, the effect of the TCJA repeal of the federal AMT is to terminate the Florida AMT for corresponding tax years. Carryforward of unused Florida AMT credits pursuant to Section 220.186(2)-(3) should continue until the credits are fully utilized.
Preliminary estimates put the fiscal impact of repealing the state AMT at a loss of $64 million – $65 million for tax years 2018-2019.
Base Erosion Anti-Abuse Tax (BEAT) – IRC Section 59A
BEAT is a new tax imposed under Section 59A on large corporate taxpayers with deductible payments to related foreign entities. BEAT is a separate tax calculated in addition to the regular federal corporate income tax.
Because it is calculated separately from a taxpayer’s regular federal corporate income tax liability, BEAT is not expected to affect state corporate income taxes. Unless the Legislature specifically adopts a Florida version of BEAT or requires an addition of BEAT to the Florida tax base as determined under Section 220.13, this provision of the TCJA will not affect the Florida corporate income tax system.
Global Intangible Low-Taxed Income (GILTI) – IRC Section 951A
New Section §951A imposes tax on income received by U.S. shareholders from controlled foreign corporations in excess of a deemed return on the tangible assets of that foreign entity. An effective tax rate lower than the normal federal corporate tax rate is achieved through certain deductions under IRC Section 250, which are “special deductions” reported on line 29 of the federal return.
Roughly a dozen states have thus far decoupled from GILTI. Unless the Florida Legislature specifically excludes GILTI from the Florida tax base, conformity with TCJA would result in a substantial revenue increase to the state (preliminary estimates of $73 million – $118 million for tax years 2018 and 2019). If the Legislature accepts this revenue increase, the Section 250 deductions should automatically be picked up since Florida conforms to line 30 of the federal return as the starting point for determining taxable income.
If the Legislature does not exclude GILTI from the Florida tax base, federal constitutional limitations prohibiting discrimination against foreign commerce and limiting the state tax base may prevent Florida from taxing this income in any event. Even if Florida were not prohibited from taxing GILTI, other federal constitutional requirements may affect the apportionment of that income.
Deduction for Foreign-Derived Intangible Income (FDII) – IRC Section 250
New Section 250 permits domestic corporations to deduct a portion of their foreign-derived intangible income attributable to sales of property to foreign persons (or for foreign use) and services provided to foreign persons (or with respect to foreign property). The deduction is limited if the sale of goods or services is to a foreign related party.
Because new Section 250 is a “special deduction’ reported on line 29 of the federal return, FDII will automatically be picked up in line 30, the starting point for determining taxable income for Florida corporate income tax purposes.
Increase in limits on expensing certain business assets – IRC Section 179
Section 179 allows business to expense specified business assets. The thresholds have varied over time, and immediately prior to the TCJA the limitation (before other adjustments) was $500,000. The TCJA increased the limitation to $1,000,000 for property placed in service after December 31, 2017. Although in earlier years the Florida legislature required an add-back of a portion of the amount deducted at the federal level (a partial “decoupling”), beginning in 2016 and continuing through 2018, Florida law has conformed to the federal treatment.
The section 179 deduction is a significant stimulus for investment and should be continued.
Bonus depreciation – IRC Section 168(k)
Beginning with the Economic Stimulus Act of 2008 Congress has provided a “special allowance” which increased the depreciation of specified property and now generally applies to property placed in service before 2027. With some exceptions, bonus depreciation begins with a deduction of 100% of adjusted basis for property placed in service after September 27, 2017, and before January 1, 2023, and the deduction is gradually reduced to 20% of adjusted basis for property placed in service thereafter through December 31, 2026. Florida has decoupled from these provisions by requiring an add-back of this “bonus depreciation” and a subtraction of one-seventh of the amount added back for the taxable year and each year for the ensuing six taxable years. This Florida treatment has continued in the wake of the TCJA.
Florida has its own fiscal needs to take into account, but the philosophy underlying bonus depreciation at the federal level is that it promotes economic activity which ultimately generates increased tax revenues and employment. If that philosophy is also embraced by Florida lawmakers, consideration should be given to conforming to the federal treatment during the 2019 legislative session.
Deduction of dividends from foreign corporations – IRC Section 245A
Prior to the TCJA and with exceptions (including certain subpart F income), the foreign income of a domestic corporation’s foreign subsidiary was taxed at the federal level at the time the earnings were distributed as dividends. A foreign tax credit was generally available to offset (at least partially) the U.S. tax. This system has been replaced with a deduction for the “foreign-source portion” of dividends received from a “specified 10% owned foreign corporation” (these are defined terms), and disallowance of a foreign tax credit.
The 2018 Florida legislation adopting the Internal Revenue Code conforms to the federal treatment. The fiscal impact of this change on Florida was estimated earlier in 2018 to average approximately $200M in additional tax revenue annually through 2024.
The federal change was designed to remove the incentive to delay distribution of earnings to domestic shareholders.
Taxability of certain federal, state, and local tax incentives – IRC Section 118
Cash and property contributed to a corporation are generally not considered income to the corporation. Although contributions in aid of construction (CIAC) by customers (and potential customers) were generally excluded from this tax-free treatment, the exclusion permitted tax–free treatment of for contributions of property by governmental units or civic groups as incentives to locate or expand corporate facilities.
The TCJA substantially narrowed the conditions for tax-free treatment. In addition to continuing the general taxable treatment of CIAC, the law now expressly provides that contributions by government entities and civic groups (other than as shareholders) are included in gross income. This change generally applies to contributions after the date of enactment (December 22, 2017); however, the change does not apply to contributions after the date of enactment “by a governmental entity, which is made pursuant to a master development plan that has been approved prior to such date by a governmental entity.” The words “master development plan” are undefined in the TCJA. A Florida definition appears in section 166.3251, Florida Statutes in connection with local manufacturing development programs, but other documents function in similar ways without having a statutory definition.
Florida has not decoupled from the new federal treatment, which was estimated earlier in 2018 to add an average of $2.2M annually in state revenues. The federal law change, and to a lesser extent the conformity of Florida’s tax code to the IRC, will likely discourage projects that further a public interest.
Dean Mead’s State and Local Tax Team is continuing to provide input to the Department of Revenue’s working group regarding its TCJA review project, and participating in the scheduled workshops. We would be glad to discuss your issues and concerns in relation to that process. For assistance with these and other state and local tax matters, please contact a member of our State and Local Tax Team.
About the Authors:
H. French Brown, IV focuses on state and local taxation, governmental relations and lobbying, and administrative law. Prior to joining Dean Mead, Mr. Brown was in private practice at another Tallahassee law firm. He began his legal career at the Florida Department of Revenue, where he quickly rose to the position of Deputy Director of Technical Assistance and Dispute Resolution. Mr. Brown also assists businesses with Florida tax planning and controversies. He may be reached at email@example.com.
Robert S. Goldman offers clients over 40 years of experience practicing in state and local taxation. He represents clients in audits, protests, litigation, rulemaking, tax planning, and legislation. His experience includes all the major state and local taxes (sales taxes, property taxes, corporate income taxes, communications service taxes, gross receipts taxes, insurance premium taxes, documentary stamp taxes). Mr. Goldman’s range of experience spans diverse industries including retail, manufacturing, energy, leasing, hospitality, telecommunications, government contracting, health care, transportation, and the service sector. He may be reached at firstname.lastname@example.org.
Mark E. Holcomb has 33 years of experience practicing in state and local taxation. He represents clients before the Florida Department of Revenue and local taxing authorities, and in litigation at the trial and appellate levels. Mr. Holcomb advises clients on a broad range of state and local taxes, including corporate income and franchise tax, sales and use tax, documentary stamp tax, communication services tax, insurance premium tax, ad valorem tax and motor fuels tax, in tax controversy work and in planning opportunities. He may be reached at email@example.com.