Federal Tax Overview
The Tax Cuts and Jobs Act (TCJA) (P.L. 115-97) contains the most significant changes to the Internal Revenue Code (IRC) in more than 30 years. At the federal tax level, the TCJA includes various international corporate tax provisions that are intended to broaden the tax base while reducing the tax rate and providing an overall reduction in federal corporate income tax. One of these provisions, effective for tax years beginning on or after January 1, 2018, is the concept of global intangible low-taxed income (GILTI). The objective of GILTI is to stop domestic corporations from transferring intangible property and their related income to low-tax foreign jurisdictions by subjecting the income to current U.S. federal taxation. Even though it targets income related to intangible assets, it applies to any type of income that exceeds a routine return on net tangible assets.
Similar to the Subpart F federal taxable income inclusion, GILTI is a provision to tax a U.S. shareholder’s share of its controlled foreign corporation’s global intangible low-taxed income at a reduced effective tax rate of 10.5 percent (13.125 percent beginning in 2026). The corporate taxpayers may take a special deduction under new IRC Section 250 equal to at most 50 percent of its GILTI, plus any corresponding IRC §78 gross-up and up to 37.5 percent of the taxpayer’s foreign-derived intangible income. For tax years beginning after December 31, 2025, the deduction for corporate taxpayers allowed under this provision is reduced to 21.785 percent and 37.5 percent, respectively. It must be noted that non-C corporation U.S. shareholders are not entitled to the 50 percent GILTI deduction.
State Tax Considerations
States generally use federal taxable income as the starting point for their state income tax base. As a result, in most states GILTI should automatically be included in the taxable income starting point. Nevertheless, a state may have an applicable exclusion/subtraction. Examples of such adjustments that could result in GILTI being excluded from state taxable income include the dividends received deduction (DRD) or a Subpart F subtraction.
However, for federal income tax purposes, the GILTI deduction under IRC §250 is a special deduction. Therefore, in addition to a state’s general conformity rule with respect to the IRC, the availability of a deduction under IRC §250 for state income tax purposes will depend on whether the state’s taxable income starting point is federal taxable income on federal Form 1120 line 28 or line 30. The key difference here is that federal Form 1120 line 28 is before special deductions, while line 30 is after special deductions. For pass-through entities, the special deduction under IRC §250 is not available. In states where the starting point is federal taxable income after special deductions, the net GILTI tax inclusion should be the same as it would be for federal income tax purposes. In states where the starting point is federal taxable income before special deductions, the taxpayer would be required to include GILTI in taxable income, but would not be entitled to the GILTI deduction, absent a specific state modification. This disconnect between the IRC and state IRC conformity could be problematic for taxpayers if states do not pursue a legislative fix.
At this point, most states are still determining their specific treatment of GILTI. For states that have not yet updated their IRC conformity date to match up with the TCJA and do not have rolling conformity to the IRC, GILTI is not yet applicable. For states that do have rolling conformity or have updated their conformity date to match the TCJA, special consideration must be given to the state income tax treatment of GILTI from both an income inclusion/exclusion and apportionment standpoint. For example, Georgia passed legislation to update its conformity to the IRC as well as provide that GILTI shall be excluded from the income tax base. On the other hand, in Massachusetts, which conforms to the IRC on a rolling basis and uses federal taxable income before net operating loss and special deductions as the starting point for determining Massachusetts taxable income, GILTI would be includible in the taxable base.
While legislation has been introduced through a supplemental appropriations bill that would provide that GILTI is to be treated as a deemed dividend for purposes of the states’ DRD, at this time it is unclear whether such legislation will be passed, and if not, whether the Massachusetts Department of Revenue may still take the position that GILTI should be treated as a deemed dividend for DRD purposes. In addition, states may require special expense attribution for such subtractions. In the final example, California conforms to the IRC as of January 1, 2015, meaning that the GILTI concept does not apply. However, when that income is actually repatriated back to the U.S., there will be a California income tax consequence with no corresponding federal tax consequence. For pass-through entities, it must be evaluated on a state-by-state basis if any relief through a subtraction or credit is provided at either the entity or owner level. The GILTI provisions may be detrimental to pass-through entities and their owners because the 50 percent deduction is not available to them.
This area of state tax is continually evolving and taxpayers should pay special attention to state legislative developments and conformity fixes to align with the TCJA for the 2018 tax year and beyond.
To learn more about the state tax effects of GILTI, contact Jim, Rick or your trusted BKD advisor.