By Bruce Baker and Dwayne Vande Krol
The Iowa Legislature made extensive changes to Iowa’s tax code with the passage of Senate File 2417 during its 2018 legislative session. The Legislature’s stated objective was to update and modernize Iowa’s tax system to better match the “new economy.”
The bill made changes to many of the taxes imposed and administered by the State, including individual income tax, corporate income tax, sales and use taxes, hotel/motel taxes, and motor vehicle excise taxes.More information concerning all of the changes made by Senate File 2417 can be found in the Legislative Service Agency's fiscal note and the Iowa Department of Revenue’s tax reform page.
This post will cover some of the significant changes to Iowa’s income tax laws impacting business entities. In subsequent days, look for a second post summarizing key changes to Iowa’s sales and use tax code.
- Conformity to the Internal Revenue Code
For tax years beginning on or before January 1, 2018, the “Internal Revenue Code” retains its definition for Iowa tax purposes as the IRC as enacted on January 1, 2015.As a result, certain tax benefits that were repealed by the Tax Cuts and Jobs Act of 2018 (TCJA) for federal tax purposes will continue to be available for Iowa tax purposes in 2018.Examples include the domestic production activities deduction and the deferral of gain on like-kind exchanges involving property other than real property.It also results in certain advantageous federal tax provisions not being available for Iowa tax purposes, such as the five-year built-in gain recognition period for S corporations (the period for Iowa purposes in 2018 is 10 years).
For tax years beginning in 2019, the “Internal Revenue Code” for purposes of Iowa’s tax code is defined to be the IRC as of March 24, 2018, i.e., after the enactment of the TCJA.
For tax years beginning in 2020, Iowa will become a “rolling” conformity state.Accordingly, Iowa’s tax code will conform to the IRC as enacted at the time.
Despite the increased conformity to the IRC, the Iowa tax code will continue to decouple from the treatment provided to selected items for federal tax purposes. In particular, amounts immediately deducted as bonus depreciation for federal income tax purposes will continue to not apply when computing net income for Iowa tax purposes.
- Reductions in Income Tax Rates
For tax years beginning on or after January 1, 2021, Iowa highest corporate tax rate of 12%, which applies to taxable income of $250,000 or more, will be reduced to 9.8%.
For businesses such as S corporations and LLCs whose income passes through to their owners for Iowa tax purposes, Iowa’s top individual income tax rate will be decreased as of January 1, 2019 from 8.98% to 8.53%.
- Limits on IRC Section 179 Expensing
For tax years beginning on or after January 1, 2018, an individual taxpayer’s deduction under IRC section 179 for Iowa tax purposes is limited to $70,000.The threshold at which the amount of IRC section 179 expense that can be claimed by an individual taxpayer begins to be phased out is $280,000.
For tax years beginning on or after January 1, 2019 but before January 1, 2020, the deduction under IRC section 179 for Iowa tax purposes for both individual and business taxpayers is limited to $100,000.The threshold at which the amount of IRC section 179 expense that can be claimed by an Iowa taxpayer begins to be phased out is $400,000.
Additionally, for tax years beginning on or after January 1, 2018 but before January 1, 2020, taxpayers that are allocated IRC section 179 expenses from multiple pass-through entities may elect to amortize over five years the amount of allocated IRC section 179 expenses claimed for federal tax purposes in excess of the amount allowed for Iowa tax purposes.Alternatively, such taxpayers may make the applicable adjustments to gains or losses on sale.However, no similar adjustments are allowed for years prior to 2018, resulting in the permanent loss of the excess federal IRC section 179 expense for Iowa tax purposes for those years (i.e., the Iowa code does not provide for future deductions or basis adjustments equal to the federal IRC section 179 expense deducted in excess of the amounts allowed for Iowa purposes for years prior to 2018).
For tax years beginning on or after January 1, 2020, the Iowa tax code fully conforms to the IRC section 179 expense amount of $1 million and the phase-out threshold of $2.5 million.
- Qualified Business Income Deduction Partially Allowed
The TCJA includes a new federal income deduction, referred to as the Qualified Business Income (“QBI”) deduction, for owners of pass-through entities, including S corporations, partnerships, limited liability companies taxed as partnerships, and sole proprietorships.The amount of the deduction is generally equal to 20% of qualified income from such entities.However, qualification for and calculation of the QBI deduction is subject to a number of restrictions and phase-outs (e.g., for taxpayers with higher income).
For Iowa tax purposes, taxpayers will be required to add back the following percentages of the QBI deduction claimed for federal income tax purposes:
- 75% for tax years beginning on or after January 1, 2019 but before January 1, 2021;
- 50% for tax years beginning during the 2021 calendar year;
- 25% for tax years beginning on or after January 1, 2022.
- Research and Development Tax Credit Limited
Effective retroactively to January 1, 2017, eligibility for Iowa’s R&D tax credit is limited to businesses engaged in the manufacturing, life sciences, software engineering, or aviation and aerospace industries.
Businesses that are specifically excluded by the Iowa tax code from claiming the R&D credit as of January 1, 2017 include, but are not limited to, agricultural production, contractors and subcontractors, finance or investment companies, retailers, wholesalers, transportation companies, publishers, agricultural cooperative associations, real estate companies, collection agencies, accountants, and architects.Businesses in these industries that claimed an R&D credit on their 2017 Iowa tax returns should consider whether or not to file an amended return.The Department of Revenue has stated that it will contact affected taxpayers that do not file amended returns by October 31, 2018.
- Future Contingent Changes
Senate File 2417 contains provisions that become effective as of January 1, 2023, but only if the State of Iowa hits certain budget targets, including net general fund revenues of approximately $8.3 billion and annual growth of such revenues equal to or greater than 4%.Otherwise, the effective date of such changes is deferred until the year following the first year such targets are met.
These “contingent changes” include further reduction of individual income tax rates to a top rate of 6.5%, elimination of the deduction for federal income taxes, and elimination of Iowa’s alternative minimum tax.
If you have any questions on changes to the Iowa tax code, please contact your Nyemaster Goode attorney.