The key to understanding how federal tax reform would change state tax codes and revenues is conformity. For reasons of administrative simplicity, states frequently seek to conform many, though rarely all, elements of their state tax codes to the federal tax code. This harmonization of definitions and policies reduces compliance costs for individuals and businesses with liability in multiple states and limits the potential for double taxation of income. No state conforms to the federal code in all respects, and not all provisions of the federal code make for good tax policy, but greater conformity substantially reduces tax complexity and has significant value.
States conform on either a static or rolling basis. Static conformity means conforming to the Internal Revenue Code (IRC) as of a specific date, such as January 1, 2016. Rolling conformity means adopting IRC changes as they occur. The states are roughly split between these two types of conformity. Twenty states have rolling conformity, while 18 states have static conformity. (The remaining states do not tax individual income or use their own calculation of income.) But among the states with static conformity, the dates of conformity vary widely. Massachusetts conformed to the IRC as of 2005, while many other states have conformed as of 2016 (see Appendix A).
Individual Income Taxes
The first large area of conformity is federal definitions of income. Twenty-seven states begin with federal adjusted gross income (AGI) as their income tax base. Six states use federal taxable income and three states use federal gross income as their starting point (see map below).
Even if a state uses federal AGI as its starting calculation, there can be adjustments (e.g., pension and retirement income, Social Security benefits, and federal deductibility) which diverge from the federal treatment of income. Twelve states conform to the federal standard deduction, while 10 use the federal personal exemption. Appendix A of this paper provides a full list for each state.
Corporate Income Taxes
States also conform to the IRC for corporate income tax calculations. States tend to conform to either taxable income before net operating losses or taxable income after net operating losses. Forty-one states conform to one of these two definitions of income. Two states have their own calculation of income, and the remaining states either do not tax corporate income or impose a statewide gross receipts tax (see map below).
As with individual income taxes, states then also can adjust the base level of income. For instance, many states do not conform on the length of time that net operating losses can be carried forward or backward, but the majority of states do conform to federal Section 179 bonus depreciation schedules. (Appendix B provides for a full list.)
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