States have had a year to consider the impact of the Tax Cuts and Job Act of 2018 (TCJA), and now many state legislatures are making decisions regarding which provisions they want to follow.
This is certainly the case in our region. Both Maryland and Virginia have proposed legislation addressing conformity with federal tax reform, while the District issued guidance last year on the impact of the TCJA. Most states’ income taxes are based on some level of conformity with the Internal Revenue Code, which means that the starting point for determining an individual’s or business’ state taxable income is more often than not federal adjusted gross income for individuals and federal taxable income for corporations.
The changes to the Internal Revenue Code (IRC) resulted in most taxpayers, both individuals and businesses, having a higher tax base. Thus, the starting point for most state income tax returns will increase for tax year 2018. From a federal income tax perspective, taxpayers seeing a reduction to their income tax is partly due to the TCJA reducing tax rates. For example, a corporation’s federal taxable income may increase as a result of the TCJA, but this is counteracted by a lower tax rate being applied to that income.
States must decide whether the TCJA should be revenue neutral or a revenue generator. Once that decision is made, there are a myriad of ways of implementing that policy. If the decision is to make the TCJA revenue neutral, the policy could be implemented simply by reducing tax rates. That’s exactly what a handful of states did last year. Idaho reduced their personal income tax rates from a range of 1.6%-7.4% to a range of 1.25%-6.925%. Similarly, Georgia reduced its corporate income tax rate from 6.0% to 5.75%. However, it’s more likely that we will see states picking and choosing the provisions they want to conform to and decouple from, resulting in statutory changes in multiple areas.
Aronson is monitoring developments in the region. Below is a summary of what we are seeing so far.
Pending legislation in Maryland in response to the TCJA includes:
- Increasing the standard deduction for individuals. For example, House Bill 271 and Senate Bill 87 would increase the maximum standard deduction for an individual filing a separate return from $2,250 to $6,000 and for individuals that are married filing jointly from $4,500 to $12,000. The current version of the bill, however, would not take effect until tax year 2019.
- Allowing an individual taxpayer to itemize deductions for Maryland purposes, regardless of whether the taxpayer itemizes deductions for federal purposes. Maryland law currently requires a taxpayer to claim the standard deduction on a Maryland return if the standard deduction is claimed on the federal return. This change was proposed as House Bill 327, and would take effect in tax year 2019.
- Phasing in over three years (2019-2021) a reduced corporate income tax rate. The proposed rate reduction in SB 37 would reduce the corporate income tax rate from 8.25% to 7.0%.
Virginia has a number of pending bills that would impact individual income taxpayers. Some of the more impactful changes that could result from those bills include:
- Decoupling from the TCJA’s deduction limitations for the Commonwealth’s state and local taxes and the mortgage interest deduction.
- Allowing an individual taxpayer to itemize deductions for Virginia purposes, regardless of whether the taxpayer itemizes deductions for federal purposes. Virginia law currently requires a taxpayer to claim the standard deduction on a Virginia return if the standard deduction is claimed on the federal return.
- Increasing the standard deduction for individuals. One such bill (HB 1980) includes an increase from $3,000 to $6,000 for single individuals and from $6,000 to $12,000 for taxpayers who are married and filing jointly.
On the business side, there is legislation (HB 1851) that proposes a corporate income tax rate deduction from 6.0% to 5.5%. Other proposals for businesses (in SB 1443) include establishing a subtraction from Virginia corporate taxable income for the amount of global intangible low-taxed income that is included in federal taxable income, as well as a subtraction for the amount of business interest that is disallowed as a deduction from federal taxable income.
District of Columbia
The District’s individual income tax law conforms to the Internal Revenue Code with respect to a taxpayer’s standard deduction and personal exemption, and it does not appear that the District will be changing that aspect of individual income taxation. Thus, District residents, starting in 2018, will be allowed an increased standard deduction and no personal exemption.
The District took some action last year due to the TCJA. In particular, clarifying legislation was enacted in response to the new 20% federal income tax deduction from qualified business income for pass-through entities. The District’s budget legislation added a new section to its deduction provision providing that in the case of an individual, estate, or trust, no deduction will be allowed under IRC Sec. 199A for District income tax purposes. Assuming no additional legislation is passed in the District for 2018, the District will:
- Not conform to the $10,000 state and local tax deduction limitation (i.e., property tax deductions greater than $10,000 will be allowed);
- Conform to the business interest deduction limitations in Internal Revenue Code section 163(j); and
- Not conform to the full expensing provision in Internal Revenue Code section 168(k). The District generally decouples from bonus depreciation.
If you have questions on the state income tax impact of federal tax reform, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.