Alabama adopts pandemic relief, tax reform

On Feb. 12, 2021, Alabama Gov. Kay Ivey signed two bills including significant changes to personal and business taxes and existing tax credit programs. Specifically, H.B. 170 provides pandemic-related relief, adopts a single sales apportionment factor, eliminates the state’s throwback provision, decouples from certain federal global intangible low-taxed income (GILTI) and interest expense limitation provisions, and enacts a new elective pass-through entity tax.¹ H.B. 192 reinstitutes the Growing Alabama Act² and expands the types of tax against which related credits may be applied, expands and extends the Alabama Jobs Act, and enacts new credits for minority- and women-owned businesses as well as specifically identified industries.³

Income tax changes

In an effort to provide taxpayer relief from the financial impact of the pandemic and improve the state’s business profile, H. B. 170 includes three distinct tax acts:

• Effective for tax years ending after the enactment date of the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act,⁴ the Alabama Taxpayer Stimulus Freedom Act of 2021 exempts taxpayers from including certain advance refunds, tax credits, economic impact payments, forgiven loans and grants in computing Alabama taxable income.⁵
• With various effective dates, the Alabama Business Tax Competitiveness Act adopts single sales factor apportionment, repeals the state’s throwback rule, retroactively decouples from federal IRC GILTI provisions, permits deductions for contributions of capital by Alabama and/or its political subdivisions disallowed for federal purposes under IRC Sec. 118(b)(2), and updates the state’s conformity to IRC Sec. 163(j).⁶
• For years beginning on or after January 1, 2021, the Alabama Electing Pass-Through Entity Act creates an optional pass-through entity (PTE) tax, allowing PTEs to make an election to pay income tax at the entity level.⁷

Taxpayer Stimulus Freedom Act of 2021

The Alabama Taxpayer Stimulus Freedom Act of 2021 allows taxpayers to exclude many receipts designed to provide pandemic-related relief in computing Alabama taxable income. For individuals, such receipts include tax credits, stimulus payments, advance refunds, and principal and interest payments on qualified education loans from the federal CARES Act and the Consolidated Appropriations Act (CAA).⁸ Specifically, cancellation of indebtedness income resulting from a loan forgiven under sections 1106 or 1109 of the CARES Act (generally referred to as the Paycheck Protection Program, or PPP) is exempt from the Alabama financial institution excise tax, the corporate income tax and the personal income tax to the same extent it is exempt for federal purposes.⁹ For businesses, both loans forgiven under the PPP and amounts used to pay qualifying expenses are excluded from the calculation of Alabama taxable income.¹⁰ Qualifying disaster relief payments excluded from federal income are also excluded from Alabama taxable income.¹¹ Finally, funds received from Alabama’s Coronavirus Relief Fund are not subject to the Alabama income tax, but related expenses are not deductible.¹²

Alabama Business Tax Competitiveness Act

Income tax apportionment

For tax years beginning on or after Jan. 1, 2021, taxpayers will apportion business income to Alabama using a single sales factor in place of the previously applicable traditional three-factor, double-weighted sales formula.¹³ Sales of tangible personal property remain sourced to Alabama when “property is delivered or shipped to a purchaser, other than the United States government, within the state regardless of the f.o.b. point or other conditions of the sale.”¹⁴ The state’s throwback rule for all sales of tangible personal property sent from Alabama locations to states where the taxpayer is not subject to income tax, as well as all sales to the U.S. Government, is repealed.¹⁵

Selective decoupling from TCJA

With the new legislation, Alabama modifies its conformity to several provisions enacted by the federal Tax Cuts and Jobs Act (TCJA).¹⁶ First, Alabama retroactively decouples from the GILTI provisions of the TCJA for tax years beginning after Dec. 31, 2017. In computing Alabama taxable income, taxpayers may deduct IRC Sec. 951A income to the extent that the amount was not deducted in determining federal taxable income. For any GILTI amount that is subtracted from Alabama taxable income, taxpayers are required to add back all directly or indirectly related expenses.¹⁷ Further, Alabama permits taxpayers receiving contributions of capital from Alabama and/or its political subdivisions a subtraction from federal taxable income for deductions disallowed on the federal income tax return pursuant to IRC Sec. 118(b)(2) for contributions made on or after Dec. 17, 2017.¹⁸

Finally, Alabama modifies its conformity with IRC Sec. 163(j) which was already complex due to separate company reporting considerations and existing related-party addbacks. For tax years beginning on or after Jan. 1, 2021, if an entity filing a separate or consolidated federal income tax return is not subject to the interest expense limitation under IRC Sec. 163(j), the taxpayer is not subject to an interest limitation in computing its Alabama taxable income, except for the state-level related-party interest limitation.¹⁹ The federal gross receipts test to determine exclusion from the IRC Sec. 163(j) limitation is applied to each separate entity filing on a separate company basis.²⁰ Also for tax years beginning on or after Jan. 1, 2021, if an entity filing a separate company federal corporate income tax return or consolidated federal return is subject to the interest limitation under IRC Sec. 163(j), then an Alabama limitation is imposed. For an Alabama affiliated group, the imposed limit is calculated on a separate-entity basis if a separate company Alabama corporate income tax return is required, and based on the Alabama consolidated return group where an Alabama consolidated return is filed.²¹ In this instance, the federal gross receipts test to determine exclusion from the IRC Sec. 163(j) limitation is applied at the affiliated group level.²²

The legislation clarifies that the IRC Sec. 163(j) limitation should be applied before considering the Alabama related-party interest limitations.²³ The related-party interest limitations are allocated on a pro-rata basis to the interest income recipients, along with any resulting carryforward amounts.²⁴

Alabama Electing Pass-Through Entity Act

For tax years beginning on Jan. 1, 2021, S corporations and partnerships may elect to be taxed at the entity level as an electing PTE.²⁵ The PTE will be subject to the highest marginal individual income tax rate, which is currently 5%.²⁶ The tax is based upon apportioned Alabama taxable income as defined under existing rules, and Alabama entity-level tax is not deductible to the PTE.²⁷ The PTE is required to make estimated payments pursuant to the estimated payment rules provided for corporations.²⁸ Upon making this election, the entity’s partners, members, and shareholders are not liable for taxes on their pro rata or distributive share of the PTE’s income that would otherwise be imposed by Alabama.²⁹

Qualifying entities must make an election to be taxed as a PTE on or before the 15th day of the third month following the close of the tax year for which the entity so elects. The election is binding for that tax year and all subsequent tax years until the election is revoked by the PTE. Similarly, a revocation must be submitted on or before the 15th day of the third month following the close of the tax year in which the entity no longer wants to be a PTE. Both the election and revocation must be accompanied by a vote or written consent of the members of the governing body, and a vote or written consent of the owners, members, partners or shareholders holding greater than 50% of the voting control of the entity.³⁰

Credit and incentive changes

H.B. 192 makes significant changes to Alabama’s available incentives, including establishing credits for certain underrepresented businesses, expanding jobs and investment credits for certain businesses, extending investment credits to technology companies, modifying the sunset date for the Alabama Jobs Act and increasing the annual maximum amount of related credits, and reestablishing the Growing Alabama Credit program. Specifically, a jobs credit against utility taxes, in an annual amount equal to 4% of the wages paid to eligible employees during the prior year, is established for underrepresented businesses.³¹ Similarly, a jobs credit against utility taxes equal to 4% of the wages paid to eligible employees is allowed for companies engaged in pharmaceutical, biomedical, medical technology or medical supplies manufacturing or their related research and development activities.³² Also, investment credit provisions are modified to allow for a technology company project which creates at least 10 new employees to qualify, regardless of the level of investment.³³ The credit may be used to offset business license taxes and may be carried forward for five years.³⁴ Qualifying technology companies with approved projects who have committed to establish an Alabama headquarters and which meet previously existing program requirements are permitted both a jobs credit against utility taxes equal to 4% of the wages paid to eligible employees for a 10-year period and an investment credit.³⁵ Project agreements for the these credits must be executed prior to July 31, 2023.³⁶ The total annualized balance of outstanding jobs act incentives is capped at $300 million for calendar years ending prior to Dec. 31, 2020, $325 million for calendar year ending Dec. 31, 2021 and $350 million for the calendar year ending Dec. 31, 2022. Of these maximum balances, $20 million is applicable to projects within designated jumpstart counties.³⁷ The Growing Alabama Credit program is reestablished with an extended sunset date of July 31, 2023.³⁸

Commentary

The stated intent of the Alabama Taxpayer Stimulus Freedom Act of 2021 was to ensure that any payments received by Alabama residents and small business owners in response to the pandemic be free from state income tax. By enacting such treatment, the legislature has relieved its residents of any related tax burden during this time of economic uncertainty.

The shift to a single sales factor and elimination of the historic throwback rule should also benefit Alabama-based taxpayers with significant property and payroll in the state. In particular, those who ship goods from Alabama to out-of-state customers could see a significant reduction in their apportionment percentage. Taxpayers should carefully review their sales by destination to analyze the impact of this change, and review any exclusions from the sales factor numerator representing sales to the U.S. government within Alabama.

Alabama generally requires corporate entities to file income tax returns on a separate entity basis but allows for elective consolidated filing. Because related-entity groups are generally required to file on a consolidated basis for federal income tax purposes, taxpayers faced a degree of uncertainty in determining federal conformity to TCJA provisions. By modifying and clarifying Alabama’s conformity, the legislation provides welcome clarity for taxpayers. In particular, the updated IRC Sec. 163(j) guidance which limits the interest expense for Alabama purposes to apply only in years in which it is limited for federal purposes (consolidated or separate), codifies the intended related-party guidance issued in 2018,³⁹ and specifies the interaction between future deductions of previously disallowed interest with the related-party interest rules provides valuable guidance. As Alabama does not decouple from IRC Sec. 163(j)(3) related to the carryforward of disallowed business interest, it is presumed that the methodology applied in the year of disallowance would be the methodology of computing the deduction in future periods barring any business structural or filing changes. That is to say, where the Alabama interest expense limitation is calculated on a separate entity basis in the year of disallowance (federal consolidated group), it will be permitted as a deduction in a future year based upon that entity’s separately recomputed Alabama taxable income, without regard to the federal consolidated return computation. As for conformity to IRC Sec. 951A, due to the retroactive nature of the newly enacted provision, taxpayers should review prior year returns to determine if an amendment is required. However, the newly enacted legislation contains a provision specifying that no refunds will be granted or paid for tax years ending before Jan. 1, 2020 on the basis of its provisions.⁴⁰

The Alabama Electing Pass-Through Entity Tax Act allows taxpayers that own PTE interests an opportunity to circumvent the TCJA’s $10,000 cap on the state and local tax deduction for individuals.⁴¹ However, there currently appears to be a lack of certainty with respect to the application of how these taxes will be treated when paid by resident individuals. The PTE tax is imposed on apportioned income, while the distributive share of income from the PTE is no longer subject to the Alabama income tax provisions. We expect further guidance to be issued to provide clarity around this issue.

1 AL H.B. 170, Laws 2021.
2 Previously repealed at the end of the 2020 fiscal year.
3 AL H.B. 192, Laws 2021.
4 P.L. 116-136 (Mar. 27, 2020).
5 H.B. 170 §§ 1-4.
6 H.B. 170 §§ 5-9.
7 H.B. 170, §§ 10.
8 H.B. 170, § 2. The CAA was adopted as P.L. 116-260 (Dec. 27, 2020).
9 H.B. 170, § 3.
10 H.B. 170, § 3(2).
11 H.B. 170, § 2(f).
12 H.B. 170, § 2(e).
13 H.B. 170, § 6, amending ALA. CODE ANN. § 40-27-1, Art. IV.(9).
14 H.B. 170, § 6, amending ALA. CODE ANN. § 40-27-1, Art. IV.(11).
15 H.B. 170, § 6, rescinding ALA. CODE ANN. § 40-27-1 Art. IV.(16)(b). Note that the legislation did not repeal the Alabama throwout provision for sales of services under ALA. CODE ANN. § 40-27-1 Article IV (12)(c).
16 P.L. 115-97 (Dec. 22, 2017).
17 H.B. 170, § 7, adding ALA. CODE ANN. § 40-18-35.2. Previously, Alabama conformed to the federal GILTI provision and required taxpayers to include IRC Sec. 951A income in computing Alabama taxable income. However, taxpayers were permitted to take the GILTI deduction allowed under IRC § 250, as well as a corresponding dividends received deduction, dependent upon their ownership percentage in the underlying foreign entities. This limited the net GILTI inclusion in the Alabama taxable income base.
18 H.B. 170, § 8, adding ALA. CODE ANN. § 40-18-35.3. Under TCJA, IRC § 118(b)(2) was added to specifically include the receipt of certain tax incentives in the federal taxable income base.
19 H.B. 170, § 9, adding ALA. CODE ANN. § 40-18-39.1(a).
20 H.B. 170, § 9, adding ALA. CODE ANN. § 40-18-39.1(b)(2).
21 H.B. 170, § 9, adding ALA. CODE ANN. § 40-18-39.1(b)(1).
22 H.B. 170, § 9, adding ALA. CODE ANN. § 40-18-39.1(b)(2).
23 As imposed by ALA. CODE ANN. § 40-18-35(b).
24 H.B. 170, § 9, adding ALA. CODE ANN. § 40-18-39.1(b)(3).
25 H.B. 170, § 10.
26 ALA. CODE ANN. § 40-18-5.
27 H.B. 170, § 10(e).
28 Id.
29 Id. at (f). Taxes include the Financial Institutions Excise Tax and all income taxes provided for under ALA. CODE ANN. § 40-18.
30 Id. at (d).
31 H.B. 192, § 10, adding ALA. CODE ANN. § 40-18-376.4. Related definitions are provided which clarify that women-and minority-owned businesses qualify as underrepresented entities.
32 H.B. 192, § 1, adding ALA. CODE ANN. §§ 40-18-375(a)(2).
33 H.B. 192, § 1, adding ALA. CODE ANN. § 40-18-376(a)(3) and amending ALA. CODE ANN. § 40-18-376(b)(1), (2) .
34 H.B. 192, § 1, amending ALA. CODE ANN. § 40-18-376(b)(3).
35 H.B. 192, § 1, amending ALA. CODE ANN. § 40-18-376.3.
36 H.B. 192, § 1, amending ALA. CODE ANN. § 40-18-382.
37 H.B. 192, § 1, amending ALA. CODE ANN. § 40-18-383(a).
38 H.B. 192, §§ 6, 9.
39 Analysis of Federal Tax Law Revisions on The State of Alabama, Executive Summary Pending Any State Law Changes, Alabama Department of Revenue, July 30, 2018 (https://revenue.alabama.gov/wp-content/uploads/2018/07/180730_TCJAeffectsAlabama.pdf).
40 H.B. 170, § 11.
41 Alabama is the eighth state to adopt a pass-through entity tax regime in response to the federal $10,000 cap. Other states with similar regimes include Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island, and Wisconsin. As of this time, only Connecticut’s workaround is mandatory. Please see Grant Thornton’s prior SALT alerts for detailed descriptions of these pass-through entity tax programs.

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