On Feb. 12, 2021, Alabama Gov. Kay Ivey signed House Bill 170, making several dramatic revisions to Alabama’s tax system including adopting single-sales factor apportionment, repealing the ‘throwback’ rule, creating a SALT limitation deduction workaround, exempting federal COVID-19 relief from state taxation, decoupling from the federal Global Intangible Low Taxed Income (GILTI) and making changes to the treatment of the federal interest limits under section 163(j).
Corporate tax changes
House Bill 170 adds Alabama to the growing list of states that now require businesses to use the single-sales factor apportionment when determining state corporate income tax liability. Twenty-seven states and the District of Columbia now use single-sales factor apportionment formulas. Alabama had been using the traditional three-factor formula of property, payroll and sales, with a double-weighted sales factor.
As significantly, the new law repeals Alabama’s throwback rule. Under that rule, sales of tangible property which are untaxed in the destination state were ‘thrown back’ and included in the numerator of Alabama’s sales factor. With repeal, twenty-one states and the District of Columbia continue to impose throwback rules. Both single-sales factor apportionment and the elimination of throwback are effective for tax years beginning on or after Jan. 1, 2021.
Federal decoupling and modifications
The new law makes two significant changes with respect to federal conformity. First, the law decouples from the federal GILTI provisions under the Tax Cuts and Jobs Act effective retroactively to tax years beginning after Dec. 31, 2017. Accordingly, Alabama taxpayers will no longer pay tax on GILTI. Second, the new law changes how Alabama addresses the federal interest limitations under section 163(j), effective for tax years beginning on or after Jan. 1, 2021. The law allows consolidated group members filing separate Alabama returns to avoid a state-level limitation if the federal consolidated group is not limited under section 163(j). If however, there is a federal consolidated limitation, the state limitation is calculated on a separate entity basis. The federal provision generally limits a taxpayer’s business interest deductions for a taxable year to the sum of: 1) 30% of the taxpayer’s adjusted taxable income for that year, 2) its business interest income and 3) floor plan financing interest.
The new law exempts all federal COVID-19 relief from state taxation. The relief specifically exempted from Alabama income tax includes economic impact payments, advance refunds, grants and small business loans forgiven under the Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Consolidated Appropriations Act of 2021. The law also conforms to the federal treatment of PPP expenses.
House Bill 170 also creates an elective pass-through entity tax to circumvent the $10,000 federal state and local tax deduction limitation, effective for tax years beginning on or after Jan. 1, 2021. The law will allow all pass-through entities to be taxed at the state’s highest marginal individual income tax rate. Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island and Wisconsin have adopted a version of a workaround tax for pass-through entities. Connecticut, the first state to adopt a workaround, is currently the only state where the tax is mandatory, rather than elective. Alabama pass-through entities considering electing into the new tax are cautioned that not all owners may benefit from such an election. As in other states that have adopted the workaround tax, making the election may, or may not, create significant tax savings when aggregating federal and state tax liabilities.
Credits and incentives
House Bill 192, signed into law the same day as House Bill 170, reinstates and expands the credits and incentives under the Growing Alabama Act (which had expired in 2020). The new law expands the available credits to the financial institutions excise tax, the insurance premium tax, and the public utility license tax. The annual cap for the credits was increased from $10 million to $20 million. The credit is available for corporations and individuals who contribute cash to state and local economic development organizations that create economic growth in industrial sites, industrial and research parks, inland ports and intermodal facilities, and STEM marketing and accelerator programs. The new law also extends the dates and increases the cap on job credits for the Alabama Jobs Act.
The various changes to the Alabama tax system will significantly affect both large and small businesses in the state. For example, the new singles sales-factor apportionment formula could create substantial tax savings for businesses that export products but have significant property and payroll in Alabama. Conversely, businesses selling into Alabama should be cognizant of this change as the absence of a property and payroll may no longer provide relief. The repeal of the throwback rule will affect companies selling into states in which they enjoy protections under federal law P.L. 86-272, the federal safe harbor prohibiting a state from imposing a net income tax on a seller's business activity if it is limited to the solicitation of orders for sales of tangible personal property.
The GILTI exclusion may affect Alabama companies doing business with related parties overseas. The changes to the state treatment of the section 163(j) limitation is likely to have even broader ramifications as the federal interest limitation affected a broad range of domestic businesses.
Alabama taxpayers are highly encouraged to discuss House Bills 170 and 192 with their state and local tax professionals for more information on these taxpayer-friendly amendments.