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Jamie C. Yesnowitz
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On Oct. 3, 2018, South Carolina Gov. Henry McMaster signed into law H.B. 5341,1
updating the state’s conformity to the Internal Revenue Code (IRC) and adopting some of the changes contained in H.R. 1, commonly referred to as the Tax Cuts and Jobs Act (TCJA).2
The legislation also includes changes to various state modifications and exemptions.
As a static conformity state, the South Carolina legislature typically advances the state’s conformity to the federal IRC on an annual basis. The enacted legislation specifies that, for tax years beginning after Dec. 31, 2017, all references to the IRC refer to the IRC as amended through Feb. 9, 2018.3
This change was necessary to reflect significant changes to the IRC resulting from the TCJA. Without such advancement, taxpayers and the South Carolina Department of Revenue would have been required to compute the South Carolina income tax base under a prior version of the IRC, potentially resulting in significant complexity and unintended tax consequences.
While South Carolina has now generally advanced its conformity to the IRC for the 2018 tax year, it continues to decouple from various provisions, which include but are not limited to: bonus depreciation, net operating loss carrybacks, deductions for state income taxes, taxes on foreign income, and consolidated reporting.4
Notably, the legislation also adopts several new modifications in determining state taxable income, including:
Personal income tax
- IRC Sec. 163(j) – South Carolina will decouple from the new federal limitations related to business interest.5 This modification will be favorable when the federal deduction of interest is limited in the current period. However, the disallowed portion of the federal deduction may be carried forward, resulting in potentially unfavorable state modifications in later taxable years when the federal income base includes interest carryforward deductions.
- Certain Foreign Income Items – South Carolina continues to decouple from the inclusion of foreign income under IRC Secs. 861-909, 912, 931-940, and 944-989. Since South Carolina did not conform to the TCJA for the 2017 tax year and historically did not conform to the federal provisions governing foreign income, South Carolina did not impose a tax on amounts deemed to be repatriated under IRC Sec. 965. Additionally, South Carolina now decouples from certain deductions relating to foreign income under IRC Secs. 250 and 267A.6 This eliminates any potential state implications arising from the federal taxation of global intangible low-taxed income (GILTI) or foreign derived intangible income (FDII) in the 2018 tax year and beyond. These modifications should typically result in taxpayer-favorable adjustments to income.
- Qualified Opportunity Zones – While South Carolina has historically decoupled from IRC Secs. 1400 – 1494, the state will conform to IRC Sec. 1400Z which allows for the deferral of capital gains which are reinvested in qualified opportunity zone funds or property.7
- Government Incentives – South Carolina will decouple from IRC Sec. 118(b)(2), which requires the value of incentives contributed by governmental entities to be included in taxable income.8 This modification will generally be taxpayer-favorable.
- IRC Sec. 199A Qualified Business Income – For federal income tax purposes, certain owners of eligible pass-through business entities may receive a deduction for up to 20% of the amount of pass-through income. South Carolina will not conform to this deduction.9 This adjustment will usually result in an unfavorable adjustment to the state tax base.
While many of the conformity changes were targeted at business taxpayers, the legislature also made certain changes to the taxation of individuals in an effort to offset potential tax increases resulting from the TCJA. The state conforms to the increased standard deduction allowed for federal purposes but also provides for a $4,110 personal exemption for each dependent claimed on the return.10
An additional $4,110 deduction is provided for each qualifying dependent under the age of six.11
Each of these adjustments will be adjusted annually for inflation.12
In addition to adjusting the tax base through personal exemptions and deductions, the legislature has also called for the tax brackets to be adjusted annually beginning in 2019 to account for inflation using the chained consumer price index.13
Only the brackets will be subject to adjustment while the applicable rates will remain constant. Because the maximum rate of 7% applies to taxable income of at least $14,860, the adjustments will be relatively small.
South Carolina lagged significantly behind many other static conformity states in its passage of tax conformity legislation. The issue was carried over long after the General Assembly adjourned from its normal session in May, and the delay was somewhat surprising given Republican control of the legislature and the incumbent Republican governor, on the heels of Republican-driven federal tax reform. Without action on conformity, South Carolina taxpayers, both businesses and individuals alike, were likely to see a tax increase, with estimates in excess of $200 million. While the adjustments are generally taxpayer-favorable and welcomed, the legislature stopped short of reducing the corporate and/or individual tax rates as implemented in several other states, including Georgia and Florida. Reform efforts also stopped short of the drastic reform seen this year in other states such as Kentucky and New Jersey.
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