Editor: Greg A. Fairbanks, J.D., LL.M.
A state's conformity to the Internal Revenue Code (IRC) is an important policy choice that affects state corporate income tax regimes using a measure of income determined by the IRC, such as federal taxable income, as the starting point for state taxable income computations. Due to the significant changes to the Code enacted by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, in 2017 and the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, in 2020, the version of the IRC that is adopted by states has become increasingly important in recent years.
The state-specific impact of the federal tax legislation depends largely on how each state conforms to and incorporates changes to the IRC. States generally follow one of three different approaches to IRC conformity. "Rolling" conformity states automatically tie to the IRC as changes are adopted. In contrast, "static" or "fixed date" conformity states adopt the IRC as of a specific date and must decide whether to update their conformity through subsequent legislation. Finally, "selective" conformity states selectively conform to certain provisions of the IRC while decoupling from others. The rolling conformity approach may initially seem fairly easy to follow, but this approach is sometimes difficult to apply in certain states in practice, with potentially counterintuitive results. This discussion examines the complex approaches used by Colorado, Maryland, and Oregon to adopt the IRC on a rolling basis.
Colorado law defines the IRC as "provisions of the federal 'Internal Revenue Code of 1986,' as amended, and other provisions of the laws of the United States relating to federal income taxes, as the same may become effective at any time or from time to time, for the taxable year" (Colo. Rev. Stat. §39-22-103(5.3)). The statutory inclusion of the language "at any time" has been widely interpreted to mean that Colorado is a rolling conformity state, which incorporates changes to the IRC as immediately effective, whenever enacted.
After enactment of the CARES Act on March 27, 2020, the Colorado Department of Revenue (DOR) released an emergency regulation to clarify the state's conformity to IRC changes (Colo. Code Regs. §39-22-103(5.3)). On July 31, 2020, the DOR permanently adopted this regulation. The CARES Act includes provisions that are retroactive to various effective dates, as early as Sept. 27, 2017. In its regulation, the DOR explains that its interpretation of the Colorado conformity statute is that IRC changes are effective only on a prospective basis. Specifically, the regulation provides in part that the IRC "does not, for any taxable year, incorporate federal statutory changes that are enacted after the last day of that taxable year." Any changes made by the CARES Act will therefore not be effective for Colorado purposes for tax years ending before March 27, 2020.
The Maryland corporate income tax computation begins with the corporation's federal taxable income for the tax year as determined under the IRC, subject to certain adjustments (Md. Code, Tax-Gen. §10-304(1)). Maryland generally is a rolling conformity state, but Maryland automatically decouples from certain federal changes for one year. Specifically, an amendment to the IRC does not apply to the tax year that begins in the calendar year in which the amendment is enacted if the revenue impact is greater than $5 million (Md. Code, Tax-Gen. §10-108(c)). Maryland is required to issue a report of the revenue impact within 60 days of when the amendment to the IRC is enacted (Md. Code, Tax-Gen. §10-108(b)).
Oregon law defines the IRC for corporation excise and income tax purposes as the laws as they are amended and in effect: (1) on Dec. 31, 2018; or (2) "[i]f related to the definition of taxable income, as applicable to the tax year of the taxpayer" (Or. Rev. Stat. §§317.010(7) and 318.031). Thus, Oregon adopts the IRC on a rolling basis as it relates to federal taxable income, but otherwise has a static IRC conformity date. Oregon refers to its rolling conformity concept as "rolling reconnect" (Oregon Legislative Revenue Office, Oregon Income Tax Connection to Federal Law (August 2020)). As explained by the Legislature, "specific legislation disconnecting Oregon from federal law is required to avoid inherently adopting federal changes to the Oregon tax base" (id.). When determining IRC conformity, a determination must be made whether the Oregon tax base is affected by the federal change.
Inconsistent approaches to IRC rolling conformity
Unlike most other rolling conformity states, further analysis must be undertaken in Colorado, Maryland, and Oregon to determine whether and to what extent specific IRC provisions are in fact adopted on a rolling basis. The enactment of the CARES Act provides a timely example of recent federal changes to the IRC that lead to varying interpretations and different results in these rolling conformity states.
In Colorado, the recently adopted DOR regulation stating that IRC amendments are effective only on a prospective basis appears to conflict with the language of the state's conformity statute, which seemingly incorporates changes to the IRC as immediately effective, regardless of when enacted. According to the regulation, however, federal IRC changes apply only to tax years ending after the federal enactment date. Perhaps in conjunction with the adoption of the regulation, Colorado enacted legislation clarifying that the state will decouple from the provision of the CARES Act that raises the business interest expense deduction from 30% to 50% of adjusted taxable income for tax years ending between March 27, 2020, and Jan. 1, 2021 (H.B. 1420, Laws 2020, amending Colo. Rev. Stat. §39-22-304(2)(i)). The legislation also amends Colorado law to provide that the state decouples from the CARES Act provision that temporarily suspends the 80% limitation on the use of net operating loss (NOL) deductions for tax years beginning in 2018, 2019, or 2020 (H.B. 1420, amending Colo. Rev. Stat. §39-22-504(1)).
One may wonder whether this revenue-enhancing legislation was necessary if the regulation were clear as to the DOR's interpretation of Colorado's conformity statute. In any event, the DOR's interpretation is likely to create conformity scenarios in Colorado that will prove difficult to track for both calendar- and fiscal-year taxpayers. So long as the regulation is in effect, taxpayers will need to be diligent in tracking future IRC changes to determine the effective date of those changes for Colorado purposes.
The application of Maryland's delayed rolling conformity to the IRC may be explained by recent guidance released on the state's conformity to various provisions of the CARES Act. As required under Maryland law, the Office of the Comptroller issued a report concluding that each of the key provisions of the CARES Act — including the business interest expense deduction and NOL provisions — would have a revenue impact of greater than $5 million in each of the tax years affected by the legislation: 2018, 2019, and 2020 (Comptroller of Maryland, Letter to Gov. Larry Hogan et al. (June 12, 2020)). However, the Maryland conformity statute permits decoupling from federal changes only for purposes of calculating Maryland taxable income for the year in which the amendment is enacted. As such, the comptroller concluded that Maryland would automatically decouple from the major CARES Act provisions as applied to the 2020 tax year (Comptroller of Maryland, Tax Alert 07-24 (July 24, 2020)).
However, the comptroller determined that the CARES Act's technical correction to the TCJA classifying qualified improvement property (QIP) placed in service after Dec. 31, 2017, as 15-year property would have a "likely not significant" impact on Maryland revenue. Therefore, the comptroller concluded that Maryland will conform to the CARES Act provision classifying QIP as 15-year property placed in service in the 2018 tax year and beyond. Accordingly, it is important to determine exactly which IRC amendments will affect Maryland revenue to the extent that they are afforded temporary decoupling treatment. The Maryland Assembly could further address conformity issues in future legislative sessions. Depending on the revenue impact, Maryland may still conform to certain federal provisions beginning in the tax year in which they are enacted.
Finally, Oregon automatically conforms to the provisions of the IRC that relate to the definition of Oregon taxable income. Because many of the CARES Act provisions directly affect taxable income by decreasing federal deductions, Oregon automatically conforms to these provisions, including the business interest expense limitation provision and the portion of the law allowing taxpayers to carry back NOLs from 2018, 2019, and 2020 for five years (though Oregon generally decouples from the federal treatment of NOLs for corporate income tax purposes). While changes to federal deductions and exemptions often directly reduce Oregon taxable income, changes to federal income tax rates and credits are not part of the definition of taxable income. Therefore, Oregon will not automatically connect to those federal changes. Adopting these types of amendments to the IRC would require specific action from the state Legislative Assembly, as would the decision to decouple from any provisions related to taxable income. As such, careful analysis is often required to properly distinguish the federal provisions to which Oregon conforms on a rolling basis versus a static basis.
The Colorado, Maryland, and Oregon conformity contortions in reaction to the enactment of the CARES Act show that rolling conformity to the IRC may not always be as clear-cut as one would expect. In determining whether a state automatically adopts amendments to the IRC as they are enacted, taxpayers should not take all rolling conformity states for granted. Careful consultation of the relevant statutes, regulations, and administrative guidance is recommended to confirm whether a state truly conforms to all federal changes on a rolling basis.
Greg A. Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or email@example.com.
Contributors are members of or associated with Grant Thornton LLP.