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February 16, 2021
2021-0360

Alabama modifies its corporate income tax, exempts certain COVID-19-related payments from state tax, extends various tax credits

On February 12, 2021, Governor Kay Ivey signed into law HB 170 and HB 192. HB 170 makes changes to Alabama's corporate income tax law, exempts certain COVID-19-related payments from state income and financial institution excise taxes and establishes a new elective passthrough-entity-level tax intended to enable Alabama taxpayers to deduct their business taxes for federal income tax purposes. Refunds related to these changes will not be granted or paid for tax years ending before January 1, 2020.

HB 192 expands and extends the Alabama Jobs Credit and reinstates and expands the Growing Alabama Act, which provides a tax credit for cash contributions to certain local economic development organizations.

HB 170

Corporate income tax changes

HB 170 makes the following corporate income tax changes:

  • Adopts a single sales factor apportionment formula and repeals the throwback rule, effective for tax years beginning on or after January 1, 2021
  • Decouples from GILTI under IRC Section 951A, retroactively applicable to tax years beginning after December 31, 2017
  • Decouples from IRC Section 118(b)(2), applicable to contributions by Alabama or any political subdivision made on or after December 23, 2017
  • Modifies Alabama's tax treatment of the IRC Section 163(j) limitation on deductions for business interest expense, effective for tax years beginning on or after January 1, 2021

Under the new law, taxpayers may deduct, for Alabama tax purposes, any GILTI included in federal taxable income (FTI). Taxpayers must, however, add to taxable income all GILTI-related expenses deducted on their federal return. Deductions under IRC Section 250 (GILTI and foreign derived intangible income (FDII)) apply only to the extent the same income was included in Alabama taxable income.

For a tax year in which IRC Section 163(j) does not limit a taxpayer's (or its federal consolidated return group's) deduction for business interest expense on its federal return, no limitation will apply to its business interest expense deduction for Alabama purposes, other than Alabama's limitation on related-member interest expense.1 If IRC Section 163(j) applies on the federal return, however, the taxpayer must calculate the IRC Section 163(j) limitation on a separate-entity basis (or, if applicable, based on the elements of the Alabama consolidated return group) when computing Alabama taxable income.

IRC Section 163(j)(3)'s gross-receipts test applies to each separate entity subject to Alabama income tax or the Alabama consolidated return group. The IRC Section 163(j) limitation applies before the Alabama limitation on related-member interest expense. For purposes of the limitation on related-member interest expense, taxpayers must allocate the limitation calculated under this provision for net interest deductions (and any resulting carryforward) on a pro-rata basis to the interest-income recipients. In addition to applying the limitation on related-member interest expense to interest accrued or incurred in the current tax year, taxpayers must apply the limitation to business interest expense that is (1) carried forward from a prior year tax year; (2) deducted on their federal return (including consolidated returns); and (3) subject to the add-back requirement for related-member interest expense.

Taxpayers subject to this provision must provide the Alabama Department of Revenue (AL DOR) with the appropriate documentation. Taxpayers must allocate nonbusiness interest expense to nonbusiness income and calculate the limit on the business interest deduction associated with nonbusiness income on a pro rata basis. The law makes clear that nonbusiness interest expense can only be used to reduce nonbusiness income.

Pass-through entity level tax election

Effective for tax years beginning on or after January 1, 2021, a pass-through entity (PTE)2 can elect to be taxed at the entity level (hereafter, electing PTE). The election, once made, is binding for that year and all subsequent tax years; an electing PTE can revoke its election by submitting the appropriate form to the AL DOR.

An electing PTE pays tax at the highest marginal income tax rate, must pay estimated tax, must apportion tax based on the state-mandated formula (i.e., a single sales factor) and cannot deduct Alabama tax paid under this provision in calculating Alabama taxable income. Owners, members, partners and shareholders are not liable for income or financial institution excise tax on their pro rata or distributive share of an electing PTE's income.

COVID-19-related payments

Alabama exempts the following from income and financial institution excise taxes:

  • Cancellation of indebtedness income resulting from the forgiveness of Paycheck Protection Program loans
  • Small Business Administration subsidy payments
  • Emergency economic injury disaster loans (EIDL) grants
  • Targeted EIDL advances
  • Grants to shuttered venues

Expenses paid with these funds (e.g., payroll, utilities, mortgage interest, rent) will be deductible for Alabama tax purposes to the same extent they are deductible for federal tax purposes.

Amounts received from the state Coronavirus Relief Fund is not recognized as income for Alabama income and financial institution excise tax purposes.

Additional COVID-19-related amounts excluded from state income tax include:

  • Federal tax credits or advance refund payments received under the Coronavirus Aid, Relief, and Economic Security Act of 2020 (CARES Act) or the COVID-related Tax Relief Act of 2020 (RELIEF Act), or any similar COVID-19-related relief measure enacted for the 2021 tax year
  • Qualified Emergency Federal Aid Grants, to the same extent they are excluded from federal gross income under the RELIEF Act
  • Qualified disaster relief payments received as a result of the Presidential Proclamation on Declaring a National Emergency Concerning the Novel Coronavirus Disease (COVID-19) Outbreak
  • Principal or interest payments incurred by an employer on any qualified education loan that is excluded from the employee's federal gross income under the CARES Act, as amended by the Taxpayer Certainty and Disaster Relief Tax Act of 2020

These provisions are effective for tax years ending after enactment of the CARES Act (March 27, 2020).

HB 192

HB 192 expands the Alabama Jobs Act to allow an incentivized company engaged in pharmaceutical, biomedical, medical technology or medical supplies manufacturing, or related research and development, to claim an annual jobs credit against utility taxes. The credit equals 4% of wages paid to eligible employees during the prior year. A transferred investment credit under the Alabama Jobs Act can be used to offset the transferee's state license tax liability for project agreements entered into after January 1, 2021 (unused credit may be carried forward for five years). The annual cap on credits available under the Alabama Jobs Act increases to $325 million in 2021 and $350 million in 2022.

HB 192 also reestablishes the Growing Alabama Act, which provides a tax credit for cash contributions to certain local economic development organizations. The Growing Alabama Act now allows credits to be claimed against the state portion of the financial institution excise tax and the insurance premiums tax. HB 192 caps the amount of funding available under the Growing Alabama Act to $20 million per calendar year.

Credits under both the Alabama Jobs Act and the Growing Alabama Act will be denied for applications that are not approved on or before July 31, 2023.

Implications

Corporations doing business in Alabama will need to review the tax changes in HB 170 and consider how they impact 2021 returns and 2021 estimated tax payments. Taxpayers subject to GILTI will need to consider the change when filing their 2020 return, keeping in mind that refunds related to these changes will not be granted or paid for prior tax years ending before January 1, 2020.

Alabama becomes the first state to enact a PTE-level tax after the IRS released Notice 2020-75.3 This Notice announced that the IRS will issue proposed regulations clarifying that a partnership or S corporation computing non-separately-stated taxable income or loss, for federal income tax purposes, may deduct state and local income taxes imposed on its net income for the tax year at issue (see Tax Alert 2020-2690). Other states considering PTE-level taxes include Arizona, Arkansas, California, New York and Massachusetts.

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Contact Information
For additional information concerning this Alert, please contact:
 
State and Local Taxation
   • Erik Harris (erik.harris@ey.com)

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ENDNOTES

1 Ala. Code Section 40-18-35(b).

2 PTEs include Subchapter S corporations, partnerships, limited partnerships, limited liability partnerships, limited liability companies or any other entities subject to Subchapter K of the Internal Revenue Code.

3 States that had previously enacted a PTE tax similar to that of Alabama, but prior to the issuance of Notice 2020-75, include Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island and Wisconsin.

 
 

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