Spring 2018 issue of Horizons

In federal taxable income states, taxpayers transfer an amount equal to AGI less any applicable deductions (i.e. the standard deduction or itemized deductions) to the state tax return. The remaining taxing jurisdictions, such as Arkansas, use a state-specific gross income calculation to determine state income tax. Taxpayers residing in these states may see fewer impacts of federal tax reform when planning and filing state income taxes. Deduction for Pass-Through Entities H.R. 1 allows a single individual taxpayer with income below $157,500 or a couple filing jointly with income below $315,000 to deduct 20% of domestic qualified business income earned from certain partnerships, S Corporations, or sole proprietorships. For taxpayers with income in excess of the income limitations, the deduction is limited to the greater of 50% of wage income or 25% of wage income plus 2.5% of the cost of tangible depreciation property. Certain service businesses operated via pass-through entities are excluded from this deduction. This provision is structured as a deduction after the determination of federal AGI, meaning that taxpayers in the six federal taxable income states will automatically receive the benefit of the deduction at the state level, absent state legislation requiring a modification. In order for this deduction to apply in other states, proactive state legislation is required. Standard Deduction and Personal Exemption The new federal tax bill repeals the $4,050 per-person personal exemption and increases the standard deduction to $12,000 for a single filer or $24,000 for a couple filing jointly. Absent state modifications requiring addbacks of these deductions or new state legislation addressing these deductions, taxpayers in states starting with federal taxable income may have a lower tax liability than taxpayers in AGI states. However, current state laws in California, Kansas and others conform only to the now repealed personal exemption and incorporate a state-defined standard deduction.

As a result, taxpayers in these states will likely experience an increase in tax liability. Meanwhile, Missouri conforms only to the federal standard deduction. Legislation introduced in Missouri would decouple the state from the increased federal standard deduction. This legislation is not yet final but has been amended since introduction to continue the federal/state conformity. Itemized Deductions Taxpayers and many states are concerned that H.R. 1 limits the individual deduction for state and local income, property and sales taxes to $10,000 in the aggregate (or $5,000 in the case of a married individual filing a separate return). This creates complexities when calculating state income taxes for taxpayers in states like California or Colorado that allow the property tax deduction but require taxpayers to add back part or all of the state income tax deduction from the federal return. These states will be required to provide administrative or regulatory guidance to taxpayers regarding whether a state income tax addback is appropriate and how to calculate it given the new federal limitations. The federal limitation on state and local income, property and sales taxes is especially troublesome for taxpayers in states with high income tax rates, significant property taxes or a combination of the two. Media outlets have reported some states may sue the federal government regarding this provision. Other states, like California and Colorado, incentivize taxpayers to make certain charitable contributions by offering state income tax credits equal to a specified portion of the contribution. These credits offset state income taxes dollar-for-dollar. According to the Tax Foundation, roughly one-third of taxpayers itemized deductions before tax reform, while fewer than 10% of taxpayers are expected to do so after tax reform.

Spring 2018

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