CPA Practice Advisor - 30

FEATURE
TCJA / Transition Tax Audit Campaigns and the Amplification of

STATE INCOME TAX COMPLEXITY
By John Paek, Michael Spencer and Sherfon Coles-Williams

STATE INCOME TAX systems typically require the computation of a state
income tax base largely based on federal taxable income, subject to certain
state-specific modifications, and then layer on a system of allocation
and formulary apportionment to attribute income to the relevant state.
Accordingly, states generally require taxpayers to report changes in their
federal taxable income within a certain timeframe so state taxing authorities
can make appropriate adjustments.
While these reporting requirements are
not new, reporting federal changes resulting
from audits conducted pursuant to the Internal
Revenue Service ("IRS") Large Business &
International Division's ("LB&I") Tax Cuts & Jobs
Act ("TCJA") and Transition Tax audit campaigns
may be particularly complex for multi-state
taxpayers.
The TCJA, enacted in December 2017, [1]
is generally considered the most significant
overhaul of the federal income tax system to date
since the Tax Reform Act of 1986. [2] Its impact
has rippled through the state corporate income
tax systems to varying degrees, depending on: (1)
each state's conformity date for its definition of
the Internal Revenue Code ("IRC"); and (2) for the
states with an IRC conformity date on or after the
enactment of the TCJA, the extent to which the
state has adopted the TCJA provisions. A similar
analysis applies when evaluating the state tax
impact of the federal Coronavirus Aid, Relief, and
Economic Security Act ("CARES Act"), enacted
in March 2020.
In November 2019, LB&I announced its
Transition Tax campaign, aimed at promoting
compliance with IRC Section 965 and conducting
examinations "with a focus on identifying and
addressing taxpayer populations with potential
material compliance risk." [3] In May 2020, LB&I
launched its TCJA audit campaign "to closely
monitor issues on a select pool of returns and
share information learned throughout LB&I
and the IRS." [4] The stated goal of the TCJA
audit campaign is to "identify transactions,
restructuring and technical issues and better
understand taxpayer behavior under the new

30

AUGUST 2020 ■

law," and LB&I considers "the impact of the
[CARES] Act on these returns as well as any other
examined."[5]
Audits under these LB&I programs may
result in adjustments to Transition Tax, global
intangible low-taxed income ("GILTI"), the Section
163(j) interest expense limitation, and/or NOLs.
Such final determinations may trigger state tax
notification requirements, typically satisfied by
filing amended state tax returns. This process
may be onerous for a corporate taxpayer doing
business throughout the U.S., given the varying
state income tax treatment of these federal items
and the varying state notification requirements.
States such as California require corporate
taxpayers to report federal changes "[i]f any item
required to be shown on a federal tax return . . .
is changed or corrected by the Commissioner of
Internal Revenue . . . ", regardless of whether the
tax liability would increase. [6] Other states like
Maryland may only require corporate taxpayers
to report the federal change if it results in an
increase in state taxable income. [7]
As a result, determining which states would
require notification after a federal TCJA audit
could require an understanding the relevant
state's tax treatment of such federal adjustments.
Reporting federal changes to Transition Tax or
GILTI may require revisiting these issues and
considering the anticipated effect on the state
income tax base, the state dividends-received
deduction, and the apportionment factor in all
relevant states. While a taxpayer would have
dealt with these issues on its original state
income tax returns, these are still relatively novel
issues, and failing to properly notify a state may

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have consequences, such as an extended statute
of limitations or penalties.
The extended statute of limitations for
assessment may be particularly problematic in
states that permit the audit of issues unrelated
to the specific underlying federal adjustment.
While this risk existed before the Transition
Tax and TCJA audit campaigns, the CARES Act
NOL carryback rules, which permit the 5-year
carryback of losses incurred in 2018 and 2019,
expand the universe of otherwise closed years
for which state adjustments may be required on
account of federal changes.
Taxpayers with Transition Tax or TCJA audit
adjustments should know that the completion
of the federal audit could trigger reporting
requirements and additional examination at
the state level. The mult-istate reporting of the
resulting federal changes can be complex and
may require significant effort to complete, due
to varying and sometimes uncertain state tax
treatment of these federal tax issues.[8] ■
John Paek is a Principal in Deloitte Tax LLP's Multistate
Tax Services group. Michael Spencer is a Manager in
Deloitte Tax LLP's Washington National Tax Multistate
Tax Services group. Sherfon Coles-Williams is a Senior
Associate in Deloitte Tax LLP's Washington National
Tax Multistate Tax Services group.

[1] Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97,
131 Stat. 2054.
[2] Tax Reform Act of 1986, Pub. L. No. 99-514, 100
Stat. 2085.
[3] Large Business & International Active
Campaigns, IRS, https://www.irs.gov/businesses/
corporations/lbi-active-campaigns, last checked
on July 14, 2020.
[4] Id.
[5] Id.
[6] Cal. Rev. & Tax. Code § 18622(a). See also
California Franchise Tax Board Publication 1008
(May 2020) (noting that corporate taxpayers "must
report all changes or corrections to gross income
or deductions, even if the changes or corrections
do not result in an increase in tax payable to
California for any year").
[7] Md. Code Ann. Tax-Gen. § 13-409. See also Md.
Regs. Code 03.04.03.06(B)(1).
[8] As used in this document, "Deloitte" means
Deloitte Tax LLP, a subsidiary of Deloitte LLP.
Please see www.deloitte.com/us/about for a
detailed description of our legal structure.
Certain services may not be available to attest
clients under the rules and regulations of public
accounting.
https://www.irs.gov/businesses/corporations/lbi-active-campaigns https://www.irs.gov/businesses/corporations/lbi-active-campaigns http://www.deloitte.com/us/about http://www.CPAPracticeAdvisor.com
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