Tax Reform Friday: Connecticut Responds to Federal Tax Reform

On May 31, 2018, Connecticut Gov. Dannel Malloy (D) signed , enacting an entity-level tax on S corporations and pass-through entities classified as partnerships that was the subject of a recent blog by my colleague, Lindsay Trasko. The legislation also provides Connecticut’s response to various provisions of the federal tax reform act (the 2017 tax act). 

Among the statutory amendments having an impact on corporations, the legislation:

  • modifies the dividends received deduction;
  • allows a deduction for certain contributions to capital;
  • decouples from the federal limits on the business interest deduction; and
  • requires an add back of most of the enhanced asset expense deduction claimed under I.R.C. § 179.
Dividends Received Deduction

Connecticut provides a deduction for dividends received that fully offsets the dividend income a corporation receives and has not otherwise deducted from gross income. Connecticut also disallows any deduction for expenses related to dividends when determining in-state net income. Accordingly, after a corporation claims the Connecticut dividends received deduction, the corporation must add back its expenses that are related to its dividend income. The legislation amends Conn. Gen. Stat. § 12-217(a)(2) to establish that, for tax years beginning on or after Jan. 1, 2017, the amount of the addback is equal to five percent of the dividend income.

Contributions to Capital

Unless an exception applies, a corporation generally does not include in federal gross income any contribution to capital. The 2017 tax act amended I.R.C. § 118(b) to prohibit the exclusion of any contribution to capital made after Dec. 22, 2017, by any governmental entity or civic group (other than a contribution made by a shareholder). As a result of an amendment to Conn. Gen. Stat. § 12-217(a)(1), Connecticut allows a corporation a deduction for the amount of a contribution to capital made on or after Dec. 23, 2017, by the state of Connecticut or one of its political subdivisions, to the extent the contribution is included in a corporation’s federal gross income.

Business Interest Deduction

The 2017 tax act limits the amount of business interest that may be deducted under I.R.C. 163(j). For tax years beginning after Dec. 31, 2017, the amount allowed as a deduction must not exceed the sum of:

  • a taxpayer's business interest income for the tax year;
  • 30 percent of "adjusted taxable income," computed without regard to deductions allowable for depreciation, amortization, or depletion; and
  • the taxpayer's floor plan financing interest for the tax year (i.e., interest paid or accrued on debt incurred to acquire motor vehicles held for sale or lease).

Effective for tax years beginning after Dec. 31, 2017, Connecticut allows a taxpayer computing its corporation business tax liability to deduct business interest without application of the I.R.C. § 163(j) limitation.

Section 179 Expense

For property placed in service in tax years beginning after Dec. 31, 2017, the 2017 tax act increased the amount taxpayers can expense under I.R.C. § 179 to $1 million and increased the phaseout threshold to $2.5 million. Connecticut’s response requires taxpayers to add back 80 percent of any federal deduction claimed. Taxpayers then may deduct 25 percent of the amount added back in each of the four succeeding taxable years.

Continue the discussion on think and code’s State Tax Group on : With decoupling from I.R.C. § 163(j) and disallowing five percent of dividend-related expenses, is the Connecticut legislation more beneficial or detrimental to taxpayers?

For more information on the impact of Pub. L. No. 115-97, examine Tax’s , showing detailed comparisons between pre-reform law and impending changes, with pertinent cites attached.

Get a free trial to Tax: State, a comprehensive research service that provides deep analysis and time-saving practice tools to help practitioners make well-informed decisions.

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