Tax Law

State Tax Essentials: Corporate Income Tax Computations

by Robert Desiderio *

Although there is some measure of conformity with the federal corporate income tax base, every state's statute makes its measure of tax corporate income different from the federal base. Typically, there are additions and subtractions from the adopted federal starting point made when computing state corporate taxable income. These modifications result from variations in the state's power to tax or reflect policy of the state legislature. The following are the most prevalent modifications used in determining taxable income on the state level.

[1] Net Operating Losses (NOLs) Limitations

Most states permit a deduction for net operating losses (NOLs). There are three primary approaches to the method by which NOLs are permitted to be deducted...

The amount of NOL deduction permitted varies greatly from state to state. Modifications used in determining state taxable income; of the principles of apportionment; and division of business and nonbusiness income affect the determination of the NOL. A taxpayer may be required to be doing business in the state in the loss year in order to take the deduction. The tax treatment of NOLs for consolidated groups may depend on state tax reporting.

[2] Dividends Received Deduction

Most states permit a deduction, or a partial deduction, for dividends in their corporate net income tax base. Federal law permits a corporation to deduct 70% of dividends received from domestic corporations and 80% from 20%-or-more owned corporations. [IRC § 243(a)(1) and (c).] A 100% deduction is provided for dividends from small business investments companies and affiliated groups. [IRC § 243(a)(2) and (3).]...

The states in which the federal deduction is allowed often have additional statutes permitting a subtraction for dividends received in excess of the federal amount or for dividends originating from a particular source...

[3] Depreciation and Depletion

Federal depreciation rules are followed by most states imposing corporate net income taxes, including ACRS and MACRS depreciation. California does not conform to the basic federal rules. However, most states have not conformed entirely to the "bonus depreciation" rules created by the Job Creation and Worker Assistance Act of 2002. The Act provides for an additional first-year depreciation allowance equal to 30 percent of the adjusted basis of qualified property placed in service between September 10, 2001 and September 10, 2004. IRC § 168(k). Congress altered and expanded the provisions in the Jobs and Growth Tax Relief Reconciliation Act of 2003...

[4] Federal and State Interest Income

Congress, through the Intergovernmental Immunity Doctrine, has specifically provided that direct or indirect taxes may not be imposed on interest from federal obligations. The exemption from state taxation of interest from federal obligations provided by the federal statute is limited to direct obligations of the United States. Direct obligations include treasury bills, bonds, certificates, notes, and U.S. savings bonds. statutes excluding interest from the tax base vary greatly. Some exclude obligations of the U.S. possessions. Other states tax these obligations...

[5] State/Local Taxes on Income

Most states disallow deductions for state and local income taxes. There is a wide variation among the states regarding the deductibility of foreign taxes. following states provide for a deduction for income taxes imposed by other states, but deny a deduction for their own income taxes:

  • Arkansas
  • Colorado
  • Illinois
  • Iowa
  • Louisiana
  • Rhode Island
  • Tennessee

[6] Charitable Contributions

The calculation for state corporate income tax usually begins with the corporation's federal taxable income as reported on the Federal Income Tax return filed with the Internal Revenue Service. Conformity with the federal law provides for a charitable deduction in most states.

[7] Federal income Taxes

Although most states do not permit a deduction for federal income taxes paid, there are a few states that do provide for such a deduction. Those states are Alabama, Iowa, Louisiana, Missouri, and North Dakota.

[8] Other Adjustments

State statutes make various other adjustments to federal taxable income to compute state taxable income. Additions to the taxable income base may include amounts for bad debts, certain basis adjustments to adjust the amount of capital gain, the recovery of tax benefit items, damage awards, extraterritorial income, and life insurance payments.

Subtractions from the tax base may also include basis adjustments and amounts for damage awards and life insurance payments. [See, e.g., the statutory scheme of the state of California.] Other deductions relate to expenditures for jobs programs and environmental or pollution control. Under the American Jobs Creation Act of 2004, [Pub. L. 108-357.] Congress modified the deductions regarding start up and organizational expenses. [IRC §§ 195, 248,
709.] Most states have statutes that adopt the amendments of the Internal Revenue Code. New Hampshire and Texaa have not adopted the amended federal provisions. Arkansas did not adopt the amendments to IRC § 195...


* Robert J. Desiderio is a partner in Sanchez, Mowrer & Desiderio, P.C. Albuquerque, New Mexico.

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