Deemed Repatriation of Foreign Deferred Income May Decrease State Taxable Income

A revenue raising provision in the recently enacted federal tax reform legislation, the Tax Cuts and Jobs Act (the Act), may have an unintended consequence of decreasing a taxpayer’s state taxable income because of the way many states use federal taxable income as a basis for calculating the state income tax base.

As previously summarized, the Act contains a provision that requires a one-time deemed repatriation income inclusion for U.S. persons that own 10% or more of the voting power in certain foreign corporations. This has the effect of immediately taking into account certain offshore income that was previously not subject to U.S. tax. The Act allows a dividends received deduction reducing the tax rate applicable to the deemed repatriation income to 15.5% with respect to cash and cash equivalents held by an applicable foreign corporation, and 8% with respect to deemed repatriation income of other assets. A taxpayer can elect to pay the resulting tax liability over an 8-year period. The deemed repatriation tax applies to 2017 and therefor may create a 2017 income event.

The state income tax consequences of this deemed repatriation generally depends on how each state incorporates federal income tax law. For example, in determining state taxable income, the income tax laws of many states start with the amount of federal taxable income, add back the federal dividends received deduction, and allow a separate state dividends received deduction. It is unclear, however, how this general structure interacts with the new provisions created by the Act. As an example, current Oregon tax law appears to include in state taxable income the net amount deemed repatriated, does not require an addback of the federal deduction, and allows an Oregon dividends received deduction of 80% (70% if the taxpayer owns less 20% of the foreign corporation) of the gross amount deemed repatriated . As a result, taxpayers may have a net reduction in Oregon taxable income as a result of the new law.

The state tax consequences in other states may be less clear, and state legislatures are in the process of determining and implementing the proper state tax treatment of the deemed repatriation.