As of early 2022, Iowa ranks among the 10 states – with others including California, New York, Hawaii and Oregon – with the highest state income tax rates in the country. This has led to proposals to reduce and simplify state income taxes with the most recent legislation passed in 2018. But in January 2022, Governor Kim Reynolds announced a new tax reform proposal that would offer tax reductions to both Iowa corporations and individuals as well as exclude some types of income from taxes. Take a look at what this proposal involves and how it could affect you.
Iowa Personal Income Tax Basics
The state uses a progressive taxation system that has nine tax brackets in 2022 ranging from 0.33 percent (for income up to $1,743) to 8.53 percent (for income over $78,435). However, tax reform already passed in 2018 will change the system to use four individual income tax brackets ranging from 4.4 percent to 6.5 percent beginning in 2023. Also, the state taxable income base will start to align with the federal one.
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While there are standard deductions to help reduce one's taxable income, they're quite low compared to the federal standard deduction amounts as well as those of other states. As of 2022, they range from $2,210 for single taxpayers and married ones filing separately to $5,450 for joint filers. You can compare these to the 2022 federal standard deduction amounts of $12,950 for single taxpayers and married ones filing separately and $25,900 for joint filers.
Along with taxing regular income from a job or self-employment, the state taxes many types of retirement income as well. While you won't have your Social Security benefits taxed, you usually do pay Iowa taxes on distributions from other retirement accounts such as IRAs, 401(k)s and pensions. However, exclusions worth $6,000 to $12,000 annually are available based on your filing status, as long as you're at least 55. Annual distributions beyond those amounts would result in an Iowa income tax liability.
Consider also: Benefits of Higher Taxes
Effects on Iowa Individual Income Taxes
The state's high income tax rates have led the governor to propose simplifying the system over the last few years. While the 2018 changes led to reducing the brackets and rates beginning 2023, the 2022 proposal suggests further reductions and eventually a flat tax rate charged by 2026. In addition, retirement distributions from accounts such as pensions, IRAs and annuities would not be taxable anymore.
Per the governor's most recent proposal, there would be four brackets of 4.4 percent to 6 percent starting in 2023. Next, the state would get rid of one of the top brackets each year until it sets a flat tax rate of 4 percent starting in 2026. However, the Iowa Senate and House have created alternative proposals that lead to a flat tax but differ on the timing and rates. While the Iowa House agrees with the governor on a four-year path to a 4 percent flat tax rate, the Iowa Senate wants a lower 3.6 percent rate within five years instead.
These proposed changes will particularly help middle- and high-income earners who might fall in the 4.14 percent to 8.53 percent tax brackets in 2022. However, anyone who has to pay Iowa income taxes – both residents and nonresidents with taxable Iowa income – could see tax savings compared to the current system. At the same time, retirees on a tight budget would especially benefit from not having their distributions taxed anymore and not needing to worry about the lower exclusion amounts.
Iowa's Proposal and Businesses
Along with proposing major changes that affect most personal income taxpayers, the governor is interested in tax reform affecting corporations. Currently, corporate tax rates range from 5.5 percent to 9.8 percent, depending on the corporation's taxable income.
The governor's 2022 proposal wants to eventually reduce the corporate tax rate for each year that the state receives over $700 million in net corporate income taxes. The idea is for the state to use the extra tax money each year to gradually reduce the top corporate tax rate until the most a corporation would pay is 5.5 percent. The change would particularly benefit businesses with earnings of $100,000 and more since they pay at least 9 percent now.
However, the Iowa House and Senate disagree on the governor's proposed changes to corporate income taxes. The Iowa House doesn't want the corporate income tax rates changed at all. Meanwhile, the Iowa Senate wants the top rate set at 7.8 percent within five years, and it wants to remove certain tax benefits for corporations as well.
Consider also: What Is a Taxable Entity?
Iowa's Proposal and Certain Capital Gains
In addition, the governor's proposal would provide some tax relief to employees whose employers give them capital stock. Under the state's current rules, the employee would be subject to capital gains tax on the net gain of the employer-issued stock once the employee decides to sell it. The state's capital gains rate stands at 8.53 percent, which is higher than many other states. However, the state does allow a 50 percent deduction when calculating the net capital gains.
In response, the governor wants to let each qualified employee have a state tax exclusion for one qualified capital stock sold in their lifetime. The proposal would include requirements for both the company and employee, however. Specifically, the employee needs to have worked for the company 10 years or longer, and the company needs to have existed for 10 years or more in the state. This means newer businesses and employees would not benefit from the proposed exclusion.
Overall Effects of Iowa's Proposal
The proposed changes for Iowa businesses and individuals could lead to positive effects that encourage growth in the economy. Businesses could use their tax savings to expand, pay off debt or make other investments. On the other hand, individuals with taxable Iowa income can use the funds to improve their quality of living, save for the future or simply enjoy a roomier budget. In fact, the proposal for a 4 percent flat tax could provide an average tax savings of $1,300 for families.
However, some critics of the tax proposal mention that the changes may offer limited tax relief to needy individuals and could have a negative effect on public institutions. This criticism stems from the fact that high-earning taxpayers and businesses would see the most tax savings and that the estimated $1.6 billion lost in collected taxes would mean less money for social safety net programs and schools.
If you're not an individual subject to income taxes in Iowa right now – such as is the case if you live in another state and don't have any taxable Iowa income – the proposal likely won't affect you unless something changes in your situation. The same applies if you don't run a business in the state. However, Iowa's proposal could pressure other states to consider similar changes to reduce individual and corporate income taxes, so it's worth keeping updated on your state's proposals.
Consider also: Goals for Fiscal Policy
Watch for Ongoing Changes
As of Jan. 31, 2022, discussions on Iowa's tax reform are ongoing with the governor and state legislature reviewing multiple proposals. This means the prospective tax rates and timelines could change, so you'll want to stay tuned for the latest news. Also, keep in mind that new provisions could get added to the proposal during the process. The governor and state legislature will need to finish negotiating before anything gets passed and finalized.
- Tax Foundation: State Individual Income Tax Rates and Brackets for 2021
- Iowa Department of Revenue: IDR Announces 2022 Interest Rates, Deductions, Income Tax Brackets
- IRS: IRS provides tax inflation adjustments for tax year 2022
- Iowa.gov: Cutting Taxes for All Iowans
- Iowa Department of Revenue: Summary of Key Effective Dates 2021 - 2023
- The Gazette: Iowa House Tax Plan Makes 3 Proposals, and Democrats Plan Another
- TaxSlayer: Is My Retirement Income Taxable to Iowa?
- Iowa Department of Revenue: Iowa Tax Rate History
- NAS Investment Solutions: Capital Gains Tax Rates by State
- AP: Reynolds Backs $2b Tax Cut With Changes to Income Tax Rates
- Des Moines Register: Opinion: Kim Reynolds’ Tax Proposal Is neither Flat nor Fair When Looking at the Big Picture
- EY: Iowa Legislature Approves Significant Income Tax Changes, Including Coupling to Federal Bonus Depreciation, With Continued Decoupling From Limitations on Business Interest Expense