On May 31, 2018, Connecticut Governor Dannel Malloy (D) signed “An Act Concerning Connecticut’s Response to Federal Tax Reform” (S.B. 11).
For corporate taxpayers, the Act provides for expense disallowance equal to 5% of dividends. This change is particularly relevant to taxpayers expecting Section 965 income. Although Section 965 income is subject to a dividends received deduction (DRD), taxpayers must add back deductible expenses relating to such dividends. The Act also decouples from the Section 163(j) interest expense limitation and from Section 179 asset expensing.
In addition, the Act includes two measures advocated by the governor to “protect Connecticut residents from negative effects” of federal tax reform. One measure establishes a tax on certain pass-through entities that is offset by a tax credit at the individual income tax level (corporate taxpayers are also eligible for the credit). The Act also allows municipalities to provide a property tax credit to eligible individual taxpayers who make voluntary payments to municipally approved ‘community supporting organizations.’
The title of the Act makes clear its intended purpose: ameliorate the impact of federal tax reform on Connecticut taxpayers. As noted by both the Office of Legislative Research the pass-through tax is intended to prevent small business owners from being targeted by the federal tax law. Similarly, the governor stated that the community organization contribution provision may reduce “individuals’ federal taxes.”
For corporate taxpayers, decoupling from the Section 163(j) interest expense limitation may be a benefit. However, without the option of computing an actual expense attribution as an alternative, the mandatory 5% expense disallowance may be more detrimental to taxpayers.