Virginia advances federal conformity date, issues guidance addressing impact on 2017 tax returns


Eric Cheek
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Sonia Shaikh
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Jamie C. Yesnowitz
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Chuck Jones
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Lori Stolly
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Priya D. Nair
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Virginia enacted emergency legislation, Senate Bill 230 and House Bill 154, advancing the state’s conformity to the Internal Revenue Code (“IRC”) from December 31, 2016 to February 9, 2018.1 The enactment conforms the state to the Disaster Tax Relief and Airport and Airway Extension Act of 2017 (“Disaster Relief Act”), as well as most provisions contained in the Tax Cuts and Jobs Act (“TCJA”) and the Bipartisan Budget Act of 2018 (“Budget Act”) that are effective for the 2017 tax year. However, Virginia will decouple from: (i) the temporary increases in the medical expenses deduction under the TCJA; and (ii) most provisions contained in the TCJA and the Budget Act that are effective beginning in the 2018 tax year.2

Background During the latter half of 2017 and the early part of 2018, Congress enacted several major pieces of legislation. On September 29, 2017, Congress enacted the Disaster Relief Act to provide tax relief measures for zones and areas that were affected by Hurricanes Harvey, Irma, and Maria.3 The adoption of the TCJA on December 22, 2017 provided a significant overhaul of the federal income tax system.4 The TCJA not only created entirely new sections of the IRC, but also made substantial changes to existing law. While most changes resulting from the TCJA are prospective in nature, certain provisions became applicable for the 2017 tax year. Finally, the Budget Act was enacted on February 9, 2018 and reinstated numerous tax incentives that expired at the end of 2016.5 The majority of these provisions were only extended for a single year, and, as a result, are retroactively available for 2017, but remain expired for 2018.6

The impact of these Acts on Virginia taxpayers turns on the state’s conformity to the IRC. Since the early 2000s, Virginia has conformed to the IRC on a fixed date basis, with the conformity date being moved “nearly every year.”7 By the same token, while Virginia conformed in some fashion to the IRC, it has consistently decoupled from various federal tax law provisions including bonus depreciation and the five-year carryback of net operating losses (NOLs) generated during 2008 and 2009.

Senate Bill 230/House Bill 154 S.B. 230 and H.B. 154 advance the date of Virginia’s conformity to the IRC from December 31, 2016 to February 9, 2018 with certain enumerated exceptions.8 With respect to the TCJA, Virginia generally will conform to provisions affecting the computation of federal adjusted gross income of individuals or federal taxable income of corporations for taxable years beginning in 2017, except for the temporary reduction in the medical expense deduction floor.9 Virginia will also conform to TCJA provisions governing: (i) the treatment of certain individuals performing services in the Sinai Peninsula of Egypt; and (ii) relief for 2016 disaster areas. Likewise, Virginia generally will conform to provisions in the Budget Act that affect taxable years beginning in 2017.10 Accordingly, Virginia effectively will decouple from most of the significant changes made under the TCJA and the Budget Act for the 2018 tax year and beyond.

Tax Bulletin 18-1 Shortly after the enactment of the legislation, the Virginia Department of Taxation issued guidance on the state’s conformity to the Disaster Relief Act, the TCJA and the Budget Act for the 2017 and 2018 tax years as a result of the advancement of the conformity date, as well as information on how to reconcile income tax returns for the 2017 tax year.11
Specifically, the Department explained that the TCJA contained many provisions that were effective for transactions occurring on and after the date of its enactment including:

  • rollovers from 529 accounts to Achieving a Better Life Experience accounts;
  • modification of the treatment of S corporation conversions into C corporations;
  • expensing of certain costs of replacing citrus plants lost by reason of a casualty;
  • creation of qualified opportunity zones;
  • denial of a deduction for settlements subject to a nondisclosure agreement paid in connection with sexual harassment;
  • expansion of the provision relating to the non-deductibility of fines and penalties;
  • repeal of the deduction for local lobbying expenses; and
  • revision of the treatment of contributions to capital.

The Department explained that, to the extent that any of these provisions affect the computation of federal adjusted gross income for individuals or federal taxable income for corporations during the 2017 tax year, Virginia will conform to such provisions.
Given Virginia’s historic decoupling from several corporate income tax provisions, the Department took the opportunity in the Bulletin to confirm that Virginia will continue to decouple from:

  • bonus depreciation allowed for certain assets under federal income taxation;
  • five-year carryback of certain NOLs generated in the 2008 and 2009 tax years;
  • tax exclusions related to cancellation of debt income; and
  • tax deductions related to the application of the applicable high-yield debt obligation rules

The bulletin also provides guidance on the state’s conformity to specific provisions of the Disaster Relief Act and the Budget Act, as well as instructions to taxpayers on the necessary adjustments needed on 2017 income tax returns to reflect the changes resulting from the advancement of the conformity date.

Commentary Virginia’s conformity legislation highlights how states are selectively conforming to TCJA provisions. A careful consideration to which provisions of the TCJA will be followed, versus the provisions that will not, is understandable given the impact such choices will have on state coffers. At least for now, Virginia is decoupling from the vast majority of the TCJA provisions for the 2018 tax year, while conforming to the few provisions in the TCJA that impact the 2017 tax year.

With respect to the TCJA provisions with 2018 tax year effect, it is not surprising to see that Virginia continues to decouple from bonus depreciation as this is in line with its historic position on the subject. Notably, however, Virginia has decoupled from the TCJA provisions governing the treatment of NOLs under IRC Sec. 172 and the expensing provisions under Sec. 179, provisions to which the state has historically conformed. It also bears noting that Virginia has also decoupled from the increased medical expense deduction contained in the TCJA.

Virginia’s decision to decouple in large part from the TCJA may be an effort by the state to buy additional time to carefully weigh the revenue impact of conformity to specific TCJA provisions. Given that many of the provisions contained in the TCJA will impact returns for the 2018 tax year or later, Virginia has the opportunity to reconsider its conformity position during its next legislative session. The Department seems to imply as much when it stresses in the Bulletin that the general decoupling from the TCJA would continue “unless further conformity legislation is enacted.”

Virginia’s conformity to the income calculations under the TCJA for tax years beginning in 2017 is notable in that it apparently incorporates the TCJA’s deemed repatriation provision under IRC Sec. 965. In an issue brief released prior to the enactment of Virginia’s conformity legislation,12 the state addressed its treatment of foreign source income. The brief explains that foreign income is not subject to state income tax as a result of state law provisions providing subtractions for corporations for amounts included “by the operation of” IRC Sec. 951 (subpart F income) and for “foreign source income.”13 To the extent that the IRC Sec. 965 deemed repatriation amounts can be considered to arise by the operation of IRC Sec. 951, or otherwise
characterized as foreign source income, such amounts would be subtracted from the Virginia corporation income tax base, with no attendant apportionment effect to the extent a parallel exclusion from the sales factor is required.14

1 Ch. 14 (S.B. 230), Laws 2018; Ch. 15 (H.B. 154), Laws 2018. Note: S.B. 230 took effect on Feb. 22, 2018 and H.B. 154 took effect on Feb. 23, 2018. With the exception of the effective dates, both bills are identical.
2 Virginia Department of Taxation, Tax Bulletin 18-1 (Feb. 26, 2018).
3 Pub. Law No. 115-63. For a discussion of this Act, see GT Alert: Disaster Tax Relief and Airport and Airway Extension Act of 2017.
4 Pub. Law No. 115-97. For a discussion of this Act, see GT Alert: Tax Reform Law Transforming Business and Tax Planning.
5 Pub. Law No. 115-123.
6 For a discussion of this Act, see GT Alert: Congress Extends Expired Tax Provisions and Amends Tax Cuts and Jobs Act.
7 Virginia Department of Taxation, Tax Bulletin 17-1 (Feb. 6, 2017).
8 VA. CODE ANN. § 58.1-301.B.
9 VA. CODE ANN. § 58.1-301.B.6.a-.c. Under federal law, the medical expense deduction is equal to the amount of a taxpayer’s eligible medical expenses in excess of a deduction floor. Prior to the enactment of the TCJA, the deduction floor was 10 percent of federal adjusted gross income for tax year 2017. The TCJA temporarily reduced the deduction floor to 7.5 percent of federal adjusted gross income resulting in an increase in the amount of the federal medical expense deduction. See Tax Bulletin 18-1, supra.
10 VA. CODE ANN. § 58.1-301.B.7.
11 Tax Bulletin 18-1, supra.
12 Virginia Division of Legislative Services, Virginia Legislative Issue Brief: Federal Tax Reform: Virginia Impacts (No. 59, January 2018).
13 VA. CODE ANN. §§ 58.1-302; 58.1-402.C.7.-.8.
14 On March 13, 2018, the Internal Revenue Service released guidance on the reporting and tax payments for IRC § 965 inclusions on 2017 income tax returns. C corporation taxpayers are required to report these amounts for federal income tax purposes on new Form 965, Transition Tax Statement, rather than including them on Form 1120 in the computation of adjusted gross income. To the extent that amounts arising under IRC § 965 are completely excluded from the Virginia corporation income tax base pursuant to Virginia statutes, it would appear that the IRS guidance regarding how to report such amounts on the federal income tax return would not have any impact for Virginia corporation income tax reporting purposes. “Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns,” Internal Revenue Service (Mar. 13, 2018).

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