Many businesses focus on the impact that federal taxes have on their companies and their owners. But don’t overlook the impact of state taxes. In many cases, state tax rules differ considerably from federal rules. States may not use “conformity” in some or many cases, meaning they don’t follow federal rules.
Here’s a brief overview of some of the differences to watch for.
Treatment of PPP loan forgiveness
Federal rule: Forgiveness of a loan under the Paycheck Protection Program (PPP) is not treated as taxable income. Expenses covered by the loan forgiveness are deductible to the extent allowed as if no PPP loan were involved.
State rules: Some states may treat loan forgiveness as taxable income from the cancellation of debt. Others may deny deductions for expenses covered by the loan forgiveness. Some states do both. The Tax Foundation has a survey of state tax treatment of PPP loan forgiveness.
Sec. 179 deduction and bonus depreciation
Federal rules: The Tax Cuts and Jobs Act made significant changes in the ability of businesses to write off the cost of buying machinery, equipment, and certain other property. This law increased the dollar limit for the Sec. 179 deduction (“first-year expensing”) and allowed for 100% bonus depreciation (another first-year write-off).
State rules: Not all the states followed suit. Anders Minker Huber & Helm LLP, a CPA firm, has a list of the states that do not allow the higher federal dollar limit for the Sect. 179 deduction. There’s a separate list for states that don’t allow 100% bonus depreciation. Where the Sec. 179 deduction and bonus depreciation are not allowed, businesses must use lower limits for those first-year write-off options, if applicable, or just regular depreciation to recoup the cost of their investments, spreading out deductions over a set number of years.
Net operating losses
Federal rules: The CARES Act allows net operating losses (NOLs) arising in 2018, 2019, and 2020 to be carried back for 5 years as an offset to taxable income in those years. Unused amounts may then be carried forward until used up.
State rules: A number of states have different calculations for determining a net operating loss. There are also differences in carrybacks and carryovers. CCH lists the treatment of NOLs state-by-state.
Health savings accounts
Federal rules: Contributions to Health Savings Accounts (HSAs) are tax deductible (annual limits apply). While the account grows, earnings are not taxed. And distributions from HSAs used to pay for qualified medical expenses are tax free.
State rules: While most states with an income tax follow federal rules, California and New Jersey do not. Contributions are not tax deductible. And interest and capital gains earned in the account are currently taxable.
Federal rules: When a business owner dies, his or her estate may be subject to federal estate tax on the value of the estate (including the value of the business interest owned at death). The tax is due 9 months after the date of death. For federal estate tax purposes, there is a generous exemption ($11.7 million for estates of decedents dying in 2021). Using this exemption allows many businesses can be transferred without paying estate tax, or worse, having to liquidate the business to pay the tax.
State rules: States may have an estate tax (12 states plus the District of Columbia), an inheritance tax (6 states), both (Maryland) or no death tax (the majority of states). Where there is a state estate tax, the exemption amount may differ considerably from the federal amount. For example, the District of Columbia exemption for those dying in 2021 is $4 million (about a third of the federal exemption); it’s only $1 million in Massachusetts and Oregon. Find a complete list of the types of state death taxes from the Tax Foundation and specific state estate tax exemptions from the American College of Trust and Estate Council.
While the focus may be on what Congress does with tax rules (that’s what my book J.K. Lasser’s Small Business Taxes 2021 is all about), don’t overlook the impact of actions in your state house.
State tax rules for businesses may seriously affect what you (and eventually your estate) pay to your state. When in doubt about any tax matters, consult a tax professional.