Will Iowa's Tax Reform Proposal Affect You?

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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