After a very rushed flurry of activity in Congress, President Donald Trump signed legislation commonly known by its acronym TCJA (Tax Cuts and Jobs Act). This legislation had many far-reaching provisions affecting individuals as well as businesses. Also included in this legislation were some far-reaching provisions affecting businesses in international commerce.

One of these provisions was a one-time tax on previously deferred income that had not been repatriated to the United States and had not been previously taxed. This provision was included in newly enacted IRC § 965. Although the code classified this income as Subpart F income, it was treated as a one-time “deemed dividend” taxed at a special tax rate. Together with other provisions, future dividends (repatriation of this previously taxed income) would be tax free.

Another provision was included in newly enacted IRC § 951A, known as GILTI (global intangible low-tax income). Based on IRC § 965, future foreign source income would be earned tax free, whether repatriated or not. Essentially, GILTI is a minimum tax to capture U.S. taxation to the extent the foreign tax was less than at a 13.125% rate (based on the current corporate income tax rate of 21%).

Taxation of IRC § 965

When talking about state taxation of foreign income, the discussion begins with state conformity to federal income tax provisions. Here is where differences between corporations and individuals are stark. Most states, 23 to be exact, begin the computation of state corporate taxable income with federal taxable income as reported on line 28 of IRS Form 1120. Therefore, to the extent foreign source income is excluded/deferred and not included in federal taxable income, it is not included in state taxable income as well.

Another 19 states begin the computation of state corporate taxable income with federal taxable income as reported on line 30 of Form 1120. Therefore, only foreign income repatriated in the form of a dividend that is not adjusted on line 29b is included. More often, this income is included in the denominator, but not the numerator of the apportionment factor. Therefore, most states do not tax foreign source income.

Most states also follow the federal provision of excluding from income dividends received from subsidiaries to the extent that the subsidiary is at least 80% owned. There are lesser exclusions for dividends received from subsidiaries owned 50% or more but less than 80% ownership.

The “deemed repatriation” was all the state of New Jersey needed to hear to jump into action. Legislation was quickly passed retroactively reducing the dividend received deduction from 100% to 95% for 2017. Coupled with the denial of the IRC § 965 (c) deduction, New Jersey corporate filers were required to include 5% of the deemed repatriation into income. Although a special apportionment of 3.5% was available for this income, this provided New Jersey with the ability to tax at least a portion of this one-time income.

New York State, at first glance, looked very generous by excluding the income completely for corporations as “other exempt income.” There is a catch. Because this was exempt income, interest expense must be allocated to this income. In lieu of the very complicated and complex allocation scheme, New York State provides for a 40% reduction to the exemption. Essentially, 40% of the otherwise excluded income is included in taxable income. Although this income is not included in the numerator, as in New Jersey above, this did increase the tax base. A similar approach and result apply to New York City corporate taxation.

Taxation of individuals was more severe. New Jersey requires the entire IRC § 965 deemed “dividend” be included as taxable dividends with no deductions or credits to offset the tax. New York State taxes the net dividend, as does Connecticut; Pennsylvania goes so far as to leave the door open to taxation again when the income is received as a dividend in a future year.

Taxation of IRC § 951A — GILTI

State taxation of GILTI follows the same pattern as the taxation of IRC § 965 deemed dividend. In states conforming to federal taxable income, it is included after the 50% deduction provided in IRC § 250. Nonconforming states either exclude it from federal taxable income or exclude it via a dividend received deduction. Five states include the entire amount of GILTI in taxable income without reduction for the IRC § 250 deduction.

For corporations, New Jersey includes GILTI net of the 50% deduction. New York State includes 5% but then has the 40% “haircut” in lieu of interest expense allocation. Both Connecticut and Pennsylvania include the GILTI as income and then exclude it via a dividend received deduction.

Individuals, once again, generally get fully taxed on this income. New Jersey, surprisingly, excludes it completely on the basis that GILTI is a corporate concept that does not apply to individuals. New York State taxpayers are not so lucky; they must include the net GILTI income as taxable dividends. Most other states include it in “income under conformity,” as it is included in federal taxable income.

The passage of TCJA made significant change to the federal taxation of income earned by foreign subsidiaries. Previously deferred income was subjected to a one-time tax as if it had been repatriated to the United States. Additionally, a new minimum tax was enacted to capture future deferred income. The state's reaction was varied depending on the level of conformity to federal taxable income. New Jersey revised its corporate taxation of dividends to capture and tax income that was otherwise exempt from taxation. New York State and New York City had a mechanism in place from the corporate tax reform of 2015.

Individuals who were more severely taxed on the federal side, due to a lack of available deductions, were equally more severely taxed by the various states. Aside for the pass provided by New Jersey, most other states tax both the IRC § 965 deemed dividend and IRC § 951A GILTI income in full.