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Jamie C. Yesnowitz
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On April 3, 2019, Idaho enacted legislation that retroactively eliminates the state corporation income tax addback requirements for federal deductions related to foreign income adopted under the Tax Cuts and Jobs Act (TCJA).1
In responding to the TCJA’s substantial changes to the treatment of foreign income,2
Idaho initially enacted legislation last year that required taxpayers to add back certain foreign income deductions available for federal income tax purposes. As amended, the Idaho addback required for the IRC Sec. 965(c) repatriated dividend deduction is retroactively eliminated for tax years beginning on or after Jan. 1, 2017. In addition, the Idaho addbacks related to the global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII) deductions under IRC Sec. 250 and the 100% deduction for qualified foreign dividends received under IRC Sec. 245A are eliminated retroactively to Jan. 1, 2018.
Federal treatment of foreign income
The TCJA modified and added a number of provisions to the Internal Revenue Code (IRC) that impact multinational taxpayers, effectively changing the U.S. tax system from a worldwide territorial system to a quasi-territorial system. For the 2017 tax year, IRC Sec. 965 implemented a one-time transition tax on repatriated foreign earnings at 15.5% or 8% depending on the type of asset held abroad.3
The tax is mechanically calculated through an inclusion amount contained in IRC Sec. 965(a), and an exclusion amount contained in IRC Sec. 965(c). Under IRC Sec. 245A, for tax years beginning after 2017, the TCJA created a 100% dividends received deduction (DRD) for foreign sourced dividends received from 10%-or-more owned foreign corporations.4
As part of the TCJA’s effort to create a more territorial regime of taxation, it added IRC Sec. 951A to create a new class of income, GILTI, recognized by U.S. shareholders of controlled foreign corporations for tax years beginning after 2017.5
Similar to the IRC Sec. 965 calculation, an exclusion component substantially reduces the amount included in income under IRC Sec. 951A. IRC Sec. 250 provides a deduction equal to 37.5% of a domestic corporate taxpayer’s FDII and 50% of GILTI for tax years beginning after 2017.6
Idaho’s treatment of foreign income
In February and March 2018, Idaho was one of the first states to enact legislation in response to the TCJA.7
Idaho’s first IRC conformity legislation enacted last year, H.B. 355, generally adopted the IRC in effect on Dec. 21, 2017, (the day prior to enactment of the TCJA) for tax years beginning on or after Jan. 1, 2017.8
However, the legislation adopted the IRC in effect on Dec. 31, 2017, for purposes of IRC Sec. 965. The legislation also enacted an addback for amounts deducted under IRC Sec. 965 and other special deductions.9
The second IRC conformity legislation enacted last year, H.B. 463, changed the IRC conformity to Jan. 1, 2018, for tax years beginning on or after Jan. 1, 2018.10
H.B. 463 incorporated the provisions of H.B. 355, including the requirement to add back any federal deductions taken under IRC Sec. 965 to compute Idaho taxable income. Also, H.B. 463 expanded this disallowance provision and specifically required corporations to add back amounts deducted under IRC Secs. 245A and 250.11
On April 3, 2019, Idaho enacted legislation that removes the addback requirements for amounts deducted under IRC Secs. 245A, 250 and 965.12
The legislation generally is retroactively effective Jan. 1, 2018, but the elimination of the addback of the IRC Sec. 965 deduction is effective for tax years beginning on or after Jan. 1, 2017.
For purposes of computing Idaho corporation income tax for the 2017 tax year, taxpayers will continue to include repatriated income under IRC Sec. 965(a), but now are allowed to take the deduction available under IRC Sec. 965(c). Taxpayers that file on a water’s edge basis may take the 80% or 85% dividends received deduction (DRD) for foreign dividends.13
Following these deductions, and lacking current regulatory or other guidance, taxpayers must determine whether the remaining amount in the tax base is considered business or nonbusiness income, and how to source such income through the sales factor, or through allocation.14
For tax years beginning or after Jan. 1, 2018, Idaho corporate taxpayers will continue to include GILTI. The recent legislation allows taxpayers to deduct 37.5% of FDII and 50% of GILTI as provided by IRC Sec. 250. Similar to the treatment of repatriated income, an 80% or 85% DRD may be available for purposes of GILTI, leading to similar uncertainty with respect to how to apportion or allocate the amount remaining in the tax base.15
Finally, taxpayers now may deduct 100% of qualified foreign dividends received. As explained in the statement of purpose for the Idaho legislation, IRC Sec. 245A “allows a deduction on repatriated income for companies that already paid taxes on income earned in a foreign country when it was repatriated to a U.S. company post 2017.”16
The conformity legislation that Idaho enacted last year was controversial because it eliminated three federal deductions relating to foreign income that were enacted by the TCJA. As noted above, Idaho was one of the first states to consider the TCJA provisions last year. The recent legislative analysis explains that “Idaho generally conforms to the federal code for the purpose of calculating taxable income,” but “given the short time frame between passage of the federal [TCJA] and the 2018 Legislative session, policy makers did not have time to thoroughly review some complex corporate provisions and did not conform to them.”17
Thus, the legislature reconsidered its decision to decouple from the foreign income tax deductions provided by federal law. These changes are limited to corporate income tax and do not change the analysis for individuals that are subject to the repatriated income and GILTI provisions.
By conforming to the IRC in effect as of Dec. 31, 2017, and requiring corporations to add back the deduction permitted under IRC Sec. 965(c), the 2018 legislation effectively included the repatriated foreign earnings in the Idaho tax base without providing the deduction afforded under IRC Sec. 965(c) necessary to achieve the preferential rate. Accordingly, the legislation could have significantly increased a corporation’s Idaho tax base to the extent the amount was included in taxable income and if a deduction for Subpart F dividends was not available. Idaho included the repatriated income under IRC Sec. 965 without allowing the corresponding federal deduction under IRC Sec. 965(c). However, as previously noted, Idaho permits water’s edge filers to exclude 80 or 85 percent of foreign dividends, which could have mitigated the impact of the IRC Sec. 965(a) income inclusion.18
As discussed above, the legislation removing the addback requirement for the IRC Sec. 965 deduction is retroactive to tax years beginning on or after Jan. 1, 2017. Because the tax on repatriated earnings was reportable on taxpayers’ 2017 tax returns, the recent legislation could require taxpayers to reconsider how they had reflected this inclusion in their 2017 returns, resulting in the filing of amended returns.
The impact of Idaho’s recent decision to allow the federal deductions under IRC Secs. 245A and 250 that are effective for tax years beginning on or after Jan. 1, 2018, should be similarly considered. The allowance of the 100% deduction for qualified foreign dividends received provided by IRC Sec. 245A and the GILTI / FDII deductions under IRC Sec. 250 may significantly benefit taxpayers. As a result, taxpayers with foreign income should consider this change when computing their Idaho taxable income for 2018 and subsequent tax years.
Given how rapidly the federal government adopted the TCJA and its complex provisions, it is not surprising that the interpretation of how to report amounts under IRC Sec. 965 and GILTI continues. As a result, a review of these calculations is appropriate, and may necessitate amended federal income tax returns. Likewise, states are struggling with the treatment of these items as well. While Idaho’s changes may have a positive impact for taxpayers, a review of the federal analysis must be made first, prior to the filing of amended returns in Idaho and other states. Finally, not to be forgotten is the impact that this legislative change will have on ASC 740 calculations and 2019 estimated payments.
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