State Tax Implications of the GILTI to NCTI Conversion 61

The “One Big Beautiful Bill” (OBBB) is significantly changing how international income is taxed at the federal level, with surprising and often counterproductive consequences for state tax codes. These changes are leading to increased state tax liabilities and a revised tax base that, due to the quirks of state incorporation, barely resembles the federal base and largely abandons its original purpose.

While the federal conversion from the Global Intangible Low-Taxed Income (GILTI) regime to the new Net CFC-Tested Income (NCTI) regime results in a net tax cut at the federal level, states that have previously adopted GILTI are incorporating these provisions in ways that lead to tax increases. This not only boosts state tax burdens but also inverts the intent of the federal reforms. Federally, the changes aim to maintain GILTI’s original purpose: to prevent profit shifting to low-tax countries after the U.S. moved to a largely territorial tax system. However, states are inadvertently doing the opposite, increasing taxes on multinational businesses precisely when those businesses are paying more tax abroad.

This double taxation is inherently undesirable and harms the competitiveness of states that implement it. Moreover, high rates of international tax often indicate genuine foreign economic activity (e.g., sales in Europe) rather than artificial profit shifting (e.g., placing intellectual property in a low-tax country to reduce taxable income).

GILTI and the States

Before the 2017 Tax Cuts and Jobs Act (TCJA), the U.S. taxed the worldwide income of U.S. corporations and their controlled foreign corporations (CFCs), allowing credits for foreign taxes paid. The TCJA introduced a territorial tax system, generally exempting foreign income. However, to deter profit shifting, GILTI was enacted as a minimum tax on certain foreign earnings. The new NCTI regime aims for better federal calibration, but for states incorporating it, the outcome is far worse.

Under GILTI, federal law attempted to differentiate between routine and “supernormal” returns. Returns exceeding 10 percent of a CFC’s tangible assets were generally considered income from intangibles (like patents or trademarks) and were subject to GILTI, after a Qualified Business Asset Investment (QBAI) exclusion for the initial 10 percent deemed return on physical capital.

The income subject to GILTI also received a deduction (initially 50 percent) and an 80 percent offset for foreign taxes paid. The deduction meant the U.S. tax rate on GILTI was lower than on domestic income (effectively turning the 21 percent corporate income tax rate into 10.5 percent), acknowledging its foreign origin. Additionally, 80 percent of foreign taxes paid could be applied as foreign tax credits. While imperfect, this system was designed to tax CFC income only if it was “undertaxed” abroad, potentially indicating U.S. tax avoidance rather than legitimate foreign economic activity.

Unfortunately, when states adopted GILTI after the TCJA, the system largely failed at the state level. Federal provisions weren’t designed with state implications in mind, and states’ corporate apportionment rules were ill-equipped to handle foreign income.

The foreign taxes that generated federal credits were paid by the CFCs themselves. To prevent a double benefit, an equivalent share of these taxes was included in the U.S. company’s GILTI income through a “§ 78 gross-up” before the credit was applied. This worked at the federal level. However, states rarely allow foreign tax credits, even though they do conform to the gross-up. As a result, states’ GILTI bases included 80 percent of foreign taxes paid by CFCs without the corresponding tax credits, leading to increased tax liability because of those foreign taxes. These foreign tax payments are not U.S. corporate profits, which state corporate income taxes are meant to target.

Converting to NCTI

For states, converting to NCTI exacerbates these problems:

• Elimination of QBAI Exclusion: The QBAI exclusion is eliminated, bringing all CFC income into the NCTI base, not just supernormal returns. While federal changes largely offset this expansion, for states, it often results in tax multipliers.
• Adjusted § 250 Deduction: Under NCTI, the § 250 deduction is made permanent at 40 percent (it was 50 percent and scheduled to drop to 37.5 percent in 2026). This effectively increases states’ tax rates on this broader base.
• Revised Expense Allocation Rules: Previously, many expenses incurred by U.S. multinationals were allocated to their CFCs, reducing the CFCs’ taxable income (potentially subject to GILTI) but denying deductions for the U.S. parent. Under NCTI, more of these deductions are taken by the U.S. parent, leading to a larger NCTI base for CFCs. While beneficial for corporations with significant foreign tax liability (as they get U.S. deductions and can use more foreign tax credits), this expands the state tax base.
• Increased Foreign Tax Credit Inclusion: The new law reduces the limitation on foreign tax credits (the “FTC haircut”), increasing the inclusion amount from 80 to 90 percent, with a corresponding increase in the § 78 gross-up.

It’s clear why this is problematic for states. The NCTI base expands further, and the increased allowance for foreign tax credits, instead of offsetting liability, is treated as additional income to be taxed. All four major changes—eliminating the QBAI exclusion, adjusting the § 250 deduction, trimming the FTC haircut with an increased § 78 gross-up, and revising expense allocation rules—make state taxation of NCTI more aggressive than GILTI, despite these changes leading to a net tax cut at the federal level.

State Incorporation of GILTI and NCTI

Currently, 21 states include at least some GILTI in their tax base, often reducing its taxability through provisions like dividends received deductions.

• Eleven states and the District of Columbia include 50 percent of GILTI (the maximum under the § 250 deduction) and are poised to include 60 percent of NCTI due to the reduced § 250 deduction.
• Nine other states include smaller shares of GILTI, ranging from 5 to 30 percent.

Fifteen states and the District of Columbia will automatically switch from GILTI to NCTI because they have rolling conformity to changes in the Internal Revenue Code (IRC). These states include Alaska, Colorado, Connecticut, Delaware, Maryland, Massachusetts, Montana, Nebraska, New Jersey, New York, North Dakota, Oregon, Rhode Island, Tennessee, Utah, and the District of Columbia.

Another five states that currently tax GILTI have static (fixed date) conformity to the IRC, meaning they will continue to apply GILTI rules unless their lawmakers explicitly update their state tax code’s conformity to a post-OBBB version. Of these, Idaho and West Virginia, while static conformity states, were “current” before the OBBB’s enactment and typically update their conformity annually. Maine, Minnesota, and New Hampshire, however, are lagging on IRC conformity.

Some States Would Convert GILTI to NCTI, but Not All

States that incorporate IRC § 951A (GILTI) but conform to an IRC version predating the OBBB will continue to tax under GILTI parameters rather than transitioning to NCTI. Such states would need to issue guidance and worksheets for this conversion, though some states’ past delays in issuing GILTI guidance don’t bode well for timely NCTI guidance.

State taxation of GILTI never made much sense. The federal government’s rationale for a profit-shifting guardrail had little relevance to states, which have historically not taxed international income. Apportioning CFC income to states where related U.S. corporations operate bore little relation to actual activity in those states. Taxing the § 78 gross-up always meant part of the state tax base was foreign tax liability, while states failed to incorporate the foreign tax credits that were integral to the federal system. Furthermore, apportionment for GILTI has been flawed, with most states denying full factor representation (only New Mexico fully provides it), leading to an over-weighting of GILTI in the apportionment factor.

NCTI: An Even Worse Fit for States

Taxing NCTI makes even less sense. Without the QBAI exclusion, the base now includes all CFC income, not just supernormal returns. While the federal system relies more heavily on foreign tax credits (and revised expense allocation rules) to target foreign income that faced low taxes abroad, the absence of similar tax credits at the state level eliminates this distinction. This renders void the mechanism the new federal system uses to prevent NCTI from being a tax on all income of U.S. companies’ foreign affiliates.

This issue extends beyond logic or justification; it makes taxing states less competitive. Companies may actively reduce in-state sales to states taxing GILTI by using third-party distributors or routing billing through out-of-state entities, thereby reducing their exposure to both GILTI and ordinary state taxes. For some states, the location of a corporate headquarters can significantly increase GILTI exposure, as intangible receipts are sourced to commercial domiciles and some states include net GILTI in the sales factor. While GILTI accounts for a tiny fraction of state revenues, it can be a significant factor for businesses states are eager to attract.

States currently taxing GILTI should view these federal changes as an opportunity to exit the business of taxing this class of international income entirely, whether under GILTI or NCTI rules. Almost none of its federal purpose or even its intended federal base is retained when incorporated into state tax codes. States can and should say no to NCTI.