GOVERNMENT CONTRIBUTIONS TO CAPITAL MAY STILL QUALIFY FOR EXCLUSION FROM STATE INCOME TAX

AUTHOR¹

Michael I. Lurie

Historically, government contributions to capital have been excluded from the federal income tax base. This exclusion derived from a string of court cases that found that government contributions to capital are not income, and was later codified as part of Internal Revenue Code ("I.R.C.") Section 118. At the federal level, the 2017 Tax Cuts and Jobs Act ("TCJA") removed the statutory exclusion for government contributions to capital from the definition of federal taxable income. But this does not necessarily mean that government contributions to capital are now included in the state tax base in all states.

Regardless of the TCJA’s amendment to I.R.C. Section 118, government contributions to capital might be excluded from the state tax base for four reasons: (1) a few states, such as California and Texas, have fixed their conformity date prior to the TCJA; (2) some states, such as Indiana and South Carolina, have completely decoupled from the TCJA’s amendment to I.R.C. Section 118 and allow all government contributions to continue to be excluded; (3) other states, such as Alabama, have selectively decoupled from the TCJA’s amendment to I.R.C. Section 118 and statutorily allow in-state government contributions to be excluded;² and (4) and some states, such as Massachusetts, have constitutional provisions that could restrict their ability to tax government contributions to capital. Taxpayers that have received government contributions to capital since 2017 should evaluate whether they can exclude these contributions from the state tax base.