Understanding state tax conformity

Editor: Mo Bell-Jacobs, J.D.

With the passage in recent years of significant federal tax legislation, there has been considerable discussion among state tax practitioners about how federal tax changes affect or could affect taxpayers from a state income tax perspective. These federal changes include the law known as the Tax Cuts and Jobs Act (TCJA), P. L. 115-97; the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136; and the Inflation Reduction Act of 2022, P. L. 117-169. Still more potential federal tax changes are on the horizon, such as the House-passed H.R. 7024, the Tax Relief for American Families and Workers Act of 2024, which includes an extension of both full Sec. 174 domestic research and experimentation expensing and 100% bonus depreciation, as well as changes to how Sec. 163(j) business interest limitations are calculated.

The first question in analyzing federal income tax changes’ effect on state taxes is whether the individual states conform to (i.e., follow) the federal provisions under review. The AICPA State and Local Tax Technical Resource Panel has developed several resources for members and state CPA societies on state tax conformity, as noted in the”Resources” sidebar on the next page, which also provides information from other sources.

State tax conformity

In general, state income tax regimes are affected by federal tax law and regulatory changes because they conform to the Internal Revenue Code (IRC) for purposes of administrative ease either by using federal taxable income as the starting point or by incorporating the IRC in whole or in part. States that incorporate the IRC either:

• Conform to the IRC as of a specific date, commonly referred to as “static” conformity; or 
• Automatically follow the version of the IRC in effect for the current tax year, commonly referred to as “rolling” conformity.

When analyzing federal tax legislation’s impact on state taxes, taxpayers must be mindful of each particular state’s level of conformity to the IRC (static vs. Rolling) because the manner and timing for a state’s reference to an IRC-derived starting point may result in differences between the federal and state income tax treatment of new or amended federal income tax provisions.

In states with static conformity, a different state tax result relative to the federal result may be triggered in any instance where an IRC provision was added or amended after the state’s conformity date. For example, California generally conforms to the IRC as of Jan. 1, 2015. Absent specific legislation updating California’s IRC conformity date or specifically conforming to the IRC provision added or amended after the IRC conformity date, California generally would not follow federal tax legislation enacted after Jan. 1, 2015.

Therefore, due to the lag in the conformity date, California generally does not follow the federal tax legislative changes enacted as part of the TCJA, which include the global intangible low-taxed income (GILTI) regime and the Sec. 163(j) business interest limitation, as the enactment occurred after Jan. 1, 2015.

In states with either a federal taxable income starting point or rolling conformity, the federal-state difference resulting from amendments to the IRC is typically avoided. The state automatically follows all federal tax legislative changes upon federal enactment unless the state enacts specific legislation to decouple from (i.e., not follow) the federal tax legislation.

For example, for corporate tax purposes, Massachusetts generally conforms to the IRC as amended and in effect for the tax year. Therefore, Massachusetts generally follows the federal tax law changes enacted as part of the TCJA, but the state has passed specific legislation decoupling from Secs. 245A and 250, which were added by the act.

As illustrated by the example of Massachusetts, practitioners and taxpayers must be mindful of each state’s decoupling or modification provisions, among other items, when analyzing federal tax legislation’s impact on state taxes. Even when a state adopts the currently effective version of the IRC, it may decouple from specific federal provisions for fiscal or policy reasons, resulting in differences between federal and state income tax treatment.

Common areas of federal-state conformity variances

Taxpayers and practitioners should consider questions of states’ conformity when analyzing any of the below areas, among others, as federal-state variances may have a significant state tax effect:

• Federal tax legislation in general;
• Research and experimental expenditures under Sec. 174;
• Bonus depreciation under Sec. 168(k);
• The business interest limitation under Sec. 163(j);
• GILTI provisions under Secs. 951A and 250;
• Foreign-derived intangible income (FDII) under Sec. 250;
• Qualified business income under Sec. 199A;
• The dividends-received deduction under Sec. 245A;
• Net operating losses under Sec. 172;
• The treatment of disregarded entities;
• Federal consolidated return regulations under Regs. Sec. 1.1502-1 et. seq.; and
• U.S. constitutional considerations and U.S. Supreme Court developments.

Contributors

Eileen Reichenberg Sherr, CPA, CGMA, MT, is AICPA director–Tax Policy and Advocacy. Mo Bell-Jacobs, J.D., is senior manager of State and Local Tax, Washington National Tax, at RSM US LLP in the Washington, D.C., area and past chair of the SALT TRP. For more information about this column, contact thetaxadviser@aicpa.org.

RESOURCES

For more information on state tax conformity and related issues, see:

AICPA resources

Map of states’ conformity to the IRC (as it relates to the computation of taxable income) 

AICPA backgrounder on state tax conformity and conformity variances 

Yesnowitz, Jones, and Skeehan, “Significant State Conformity Issues for Corporate Taxpayers,” 54-2 The Tax Adviser 24 (February 2023) 

Yesnowitz, Jones, Stolly, and Skeehan, “Difficulties of Applying IRC Rolling Conformity in Some States,” 52 The Tax Adviser 104 (February 2021)

Other resources

Frieden and Do, “State Tax Conformity to Key Taxpayer: Favorable Provisions in the CARES Act,” 96 Tax Notes State 303 (April 20, 2020) 

National Conference of State Legislatures State and Local Taxation Task Force, including: Federal Tax Reform Under the Biden Administration and Its Implications for State Taxation (May 2021) 

Tax Foundation, including: 

Center for State Tax Policy and State Tax Maps 

Loughead, “State Conformity to Federal Pandemic-Related Tax Provisions in CARES and ARPA” (April 1, 2021) 

Loughead, “Biden Administration Changes to GILTI and FDII Will Yield Automatic State Tax Increases” (May 25, 2021)