Potential state corporate income tax consequences of the federal BEAT waiver election
This article addresses a potential state corporate income tax issue for taxpayers making the federal base erosion and anti-abuse tax (BEAT) waiver election. As discussed below, certain taxpayers may consider making the election to mitigate the federal BEAT implications. However, making an election could have some state corporate income tax consequences by increasing a state’s federal taxable income starting point.
Internal Revenue Code (IRC) Section 59A, commonly referred to as the BEAT, was enacted as part of the Tax Cuts and Jobs Act. The BEAT has not garnered much state and local tax attention because it is a federal minimum tax that no state has specifically adopted. Indeed, it has generally only merited consideration for those few states that provide a federal income tax deduction as to whether BEAT qualified for that state tax deduction. However, the federal BEAT waiver election appears to present a state and local corporate income tax issue for most states.
In general, BEAT is imposed on corporations, other than regulated investment companies (RICs), real estate investment trusts (REITs), and S corporations that have (a) three taxable-year average annual gross receipts of USD 500 million or more and (b) a “base erosion percentage” that is generally 3% or higher. Certain aggregation rules apply in determining gross receipts and base erosion percentage. Also, affiliated groups with banks and securities dealers are subject to special rules. Additional details and rules apply to calculate the tax liability imposed under IRC Section 59A.
Treasury issued proposed regulations on December 6, 2019 (REG-112607-19). The proposed regulations provide for the BEAT waiver election in Prop. Reg. §1.59A-3(c)(6), which allows a corporation to waive certain allowed deductions and, as a result, can reduce the corporation’s “base erosion percentage” below 3% to avoid imposition of the BEAT or otherwise mitigate the BEAT implications. While the proposed regulations have not been finalised, pursuant to Prop. Treas. Reg. Section 1.59A-10(b), taxpayers may apply the proposed regulations in their entirety to taxable years beginning after December 31, 2017, and before the final regulations are applicable. Taxpayers do not have to wait for the final regulations to make the BEAT waiver election. Further, the election may be made on an original return, amended return, or during the course of an audit examination of the taxpayer’s federal tax return, pursuant to procedures prescribed by the IRS.
A state corporate income tax consequence could result from the federal BEAT waiver election, as follows: Prop. Treas. Reg. Section 1.59A-3(c)(6)(ii)(A)(1) provides, “[e]xcept as otherwise provided in this paragraph (c)(6)(ii), any deduction waived under paragraph (c)(6) of this section is treated as having been waived for all purposes of the Code and regulations” (emphasis added). For federal income tax purposes, and for purposes of a corporation’s federal Form 1120, federal taxable income will also exclude (i.e., add-back) those deductions waived as a result of the BEAT waiver election. The BEAT waiver election both excludes the allowable deductions from the calculation of the “base erosion percentage,” but because the waiver is also “for all purposes of the Code,” subject to certain limited exceptions in Prop. Treas. Reg. Section 1.59A-3(c)(6)(ii), the election also excludes those allowable deductions when determining federal taxable income under IRC Section 63 and federal Form 1120 lines 28 and 30.
A state could exclude the federal deductions that were elected to be waived for purposes of mitigating the BEAT, if a state starts its calculation of state taxable income with federal taxable income, because the effect of the BEAT waiver election applies “for all purposes of the Code.” As a result, the taxpayer’s federal taxable income starting point, for state tax purposes, would be greater than it otherwise would have been without the federal BEAT waiver election.
For more details on the final regulations on the application of the BEAT, please read here.