Jamie C. Yesnowitz
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Priya D. Nair
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On February 21, 2018, West Virginia enacted legislation, H.B. 4135 and H.B. 4146, updating its conformity to the Internal Revenue Code (IRC) for purposes of the state’s corporation net income tax and personal income tax, to include amendments made to the IRC during the 2017 calendar year.1
With the advancement of the conformity date, West Virginia will now conform to key provisions contained in H.R. 1, commonly referred to as the Tax Cuts and Jobs Act (TCJA).2
Tax Cuts and Jobs Act
On December 22, 2017, Congress enacted the TCJA, bringing about a sweeping overhaul of individual, business and international taxes in the United States. Contained within the TCJA are key provisions that have the potential to substantially impact state taxable income in West Virginia.
Specifically, the TCJA revises federal provisions governing bonus depreciation, allowing for 100 percent bonus depreciation for property placed in service after Sept. 27, 2017, and before Jan. 1, 2023, with a phasedown of this percentage by 20 percent in the five following years. The TCJA also limits the deduction for net business interest in excess in interest income to 30 percent of adjusted taxable income for tax years beginning after Dec. 31, 2017.3
Any disallowed interest expense is carried forward indefinitely. The TCJA also increases the Sec. 179 expensing limit to $1 million for tax years beginning after 2017 and before 2023, with the start of the phaseout increased to $2.5 million.
Net operating losses will be limited by a TCJA provision under which NOL deductions can only offset up to 80 percent of taxable income. Additionally, while the TCJA allows for indefinite carryforwards of NOLs, carrybacks are repealed for most businesses. The 80 percent limits apply to NOLs arising from tax years beginning after Dec. 31, 2017, and the new carryforward period applies to NOLs arising in tax years ending after Dec. 31, 2017.
On the international front, the TCJA moves the United States towards a partial territorial system by implementing, under IRC Sec. 965, a one-time “transition tax” on previously unrepatriated foreign earnings that is applicable for the 2017 tax year. The transition tax is calculated by increasing Subpart F income by unrepatriated earnings from foreign subsidiaries4
and then providing a “participation exemption,” which creates a deduction that effectively reduces the tax rate on unrepatriated earnings to 15.5 percent on cash and cash equivalents, and 8 percent on non-cash assets.5
The impact that these TCJA provisions will have on state income tax turns on the type of federal conformity employed by a state. States have traditionally conformed to the IRC in one of three ways: (i) rolling conformity (automatically conforming to the IRC currently in effect); (ii) fixed date conformity (also known as “static conformity,” conforming to the IRC as of a fixed date) and (iii) selective conformity (conforming to only specific IRC sections). West Virginia is a fixed date conformity state that, prior to the adoption of H.B. 4135 and H.B. 4146, was tied to the IRC for changes made during the 2016 calendar year. In order to adopt provisions contained in the TCJA, West Virginia needed to enact legislation updating its conformity to the IRC as of December 22, 2017 or later. The enactment of H.B. 4135 and H.B. 4146 now allows the state to conform to the TCJA provisions.
H.B. 4135 / H.B. 4146
On Feb. 21, 2018, West Virginia enacted H.B. 4135 updating its conformity to the IRC, for corporate income tax purposes, to provide that “[a]ll amendments made to the laws of the United States after December 31, 2016, but prior to January 1, 2018,” will be given effect for purposes of determining the state’s corporate income tax purposes “to the same extent those changes are allowed for federal income tax purposes, whether the changes are retroactive or prospective.”6
Reference to the term “laws of the United States” is defined as the “provisions of the Internal Revenue Code of 1986, as amended, and any other provisions of the laws of the United States that relate to the determination of income for federal income tax purposes.”7
Identical legislation, H.B. 4146, was enacted to update the state’s conformity for personal income tax purposes. H.B. 4146 also addresses the TCJA’s repeal of personal exemptions by providing that, for taxable years beginning on and after January 1, 2018, references to federal exemptions in the West Virginia code will mean the federal personal exemption a taxpayer would have been allowed to claim had the federal personal exemption not been repealed.8
H.B. 4135 and H.B. 4146 both took effect on Feb. 9, 2018.
West Virginia’s conformity legislation is notable for its blanket conformity to the IRC after the enactment of the TCJA with no specific carve-out provisions. This approach is a marked departure from that taken by its neighboring state of Virginia, which opted to conform to most of the provisions contained in the TCJA effective for tax year 2017, but specifically decouple from the majority of the provisions effective for 2018 and thereafter. Virginia’s approach essentially allows that state additional time to carefully consider the revenue implications of federal conformity during its next legislative session, in advance of the due date for tax year 2018 returns. Along the same lines, for states that have already enacted conformity legislation, the trend has been to selectively conform to provisions of the TCJA and West Virginia’s conformity legislation is a move against this trend.9
By the same token, H.B. 4135 and H.B. 4146 also serve as a reflection of West Virginia’s decision to stay the course on its approach to federal conformity, particularly for purposes of the corporation income tax. Specifically, West Virginia has historically conformed to both the federal Sec. 179 expensing rules and bonus depreciation provisions, and with the advancing of the conformity date, the state should continue to conform to these provisions as revised by the TCJA. West Virginia also generally conforms to the federal NOL provisions, through a state-specific NOL “determined in accordance with Section 172 of the Internal Revenue Code of 1986, as amended.” Accordingly, the state should conform to the new NOL revisions contained within the TCJA.10
Additionally, West Virginia defines “[i]nterest expense” as amounts directly or indirectly allowed as deductions under IRC Sec. 163,11
and as a result, the state should also conform to the new interest deduction limitation under IRC Sec. 163(j).12
West Virginia’s new conformity date apparently would incorporate the TCJA’s deemed repatriation provision under IRC Sec. 965. However, West Virginia has several subtractions from taxable income that may be applied to prevent such amounts from being included in the measure of the corporation income tax, possibly as a subtraction of amounts included in federal adjusted gross income “by the operation of” IRC Sec. 951 (relating to Subpart F income),13
or likely as a subtraction for “foreign source income,” which is broadly defined as “any amount included in federal taxable income which is taxable income from sources without the United States.”14
Given the expected exclusion of these amounts from the West Virginia corporation income tax base, there would be no attendant apportionment effect to the extent a parallel exclusion from the sales factor is required.
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