Iowa adopts omnibus tax bill

On June 16, 2021, Iowa Gov. Kim Reynolds approved S.F. 619, an omnibus tax bill that adopts the federal rules regarding bonus depreciation and conforms to the federal treatment of forgiven loan proceeds under the Paycheck Protection Program (PPP) enacted as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act of 2020¹ and the Consolidated Appropriations Act (CAA).² S.F. 619 also removes the revenue triggers necessary to reduce individual income tax rates and the number of individual income tax brackets, and enact changes to corporate income tax modifications and net operating losses (NOLs) effective Jan. 1, 2023. Further, S.F. 619 phases out the Iowa inheritance tax. The omnibus legislation follows the enactment of S.F. 608 on June 8, 2021, which mandates that a pass-through entity (PTE) with nonresident owners must file a composite return on behalf of such owners at the top corporate, franchise or individual tax rate.


 

Corporate income tax changes

Bonus depreciation conformity and interest expense limitation decoupling

Omnibus legislation enacted in June 2020 provided that the interest expense limitation rules contained in Internal Revenue Code (IRC) Sec. 163(j) do not apply when computing Iowa taxable income beginning with the 2020 tax year.³ The legislation contained a provision under which the state would conform to IRC Sec. 163(j) in a tax year in which the state decided to conform to the bonus depreciation provisions in IRC Sec. 168(k).⁴

Under S.F. 619, Iowa conforms to the federal bonus depreciation provisions under IRC Sec. 168(k) for qualified equipment and capital assets, effective for tax years beginning on or after Jan. 1, 2021.⁵ Furthermore, the statutory provision requiring conformity to IRC Sec. 163(j) in the event that Iowa conforms to IRC Sec. 168(k) was also eliminated effective for tax years beginning on or after Jan. 1, 2021.⁶ As a result, Iowa now conforms to federal bonus depreciation rules under IRC Sec. 168(k), while continuing to decouple from the interest expense limitation under IRC Sec. 163(j) retroactive to Jan. 1, 2021.

Conformity to forgiven PPP Loans and exemption for COVID-19 related grants

For tax years beginning on or after Jan. 1, 2020, Iowa shifted its IRC conformity method from a static basis to a rolling basis.⁷ As a result, Iowa automatically conforms to the IRC provisions contained within the CARES Act and the CAA for the 2020 tax year, but does not do so for the 2019 tax year. This disconnect had the potential to create different outcomes for the treatment of certain tax provisions included in the CARES Act and the CAA depending on whether the taxpayer filed on a calendar-year basis or fiscal-year basis.

Legislation enacted in 2020 addressed this potential disconnect for forgiven PPP loans under the CARES Act.⁸ Under S.F. 619, Iowa conforms to the provisions of the CAA regarding the federal tax treatment of forgiven PPP loan proceeds and the deductibility of expenses paid using forgiven PPP loans for tax years ending after March 27, 2020.⁹ Finally, for qualifying COVID-19 related grants issued between March 17, 2020, and Dec. 31, 2021, to the extent such amounts are included in federal taxable income, such amounts are excluded from the Iowa tax base.¹⁰ The provision governing the taxation of grants is effective for tax years ending on or after March 17, 2020.


 

Removal of revenue triggers for previously contingent income tax changes

In 2018, Iowa enacted legislation changing various provisions of the state’s corporate and individual income tax laws contingent upon certain revenue triggers being met prior to 2023.¹¹ S.F. 619 eliminated the contingent revenue triggers and related calculations provided in the 2018 legislation, and replaced it with an affirmative effective date of Jan. 1, 2023, for all previously contingent changes.¹² The previously contingent tax changes included in the 2018 legislation that are scheduled to become effective on Jan. 1, 2023, include:

• Decreasing the number of individual income tax brackets from nine to four, and reducing the top individual income tax rate from 8.53% to 6.50%.
• Striking several Iowa modifications to federal taxable income under Iowa Code Sec. 422.7.
• Discontinuing the generation of Iowa net operating losses (NOLs) under Iowa Code Sec. 422.9, and amending the definition of “net income” for federal income tax purposes to mean taxable income after the federal NOL deduction.¹³ As a result of this change:
  • Iowa NOLs generated prior to the 2023 tax year can still be utilized to offset income generated in the 2023 tax year and beyond; and
  • Federal NOLs generated and carried over from a tax year prior to the 2023 tax year cannot be deducted when computing Iowa taxable income in the 2023 tax year and beyond.

Inheritance tax phase-out

Under S.F. 619, Iowa will phase out its inheritance tax on property passing from the estate of a decedent dying in 2021 through 2024, with full repeal of the inheritance tax becoming effective for decedents dying on or after Jan. 1, 2025.¹⁴ The inheritance tax is phased out in the following manner:

• For decedents dying in 2021, the tax is reduced by 20% of the applicable rate¹⁵
• For decedents dying in 2022, the tax is reduced by 40% of the applicable rate
• For decedents dying in 2023, the tax is reduced by 60% of the applicable rate
• For decedents dying in 2024, the tax is reduced by 80% of the applicable rate¹⁶

Individual income tax credit for certain sales / use tax payments

Under Iowa law, eligible businesses may claim a tax credit equal to the sales and use taxes paid by a third-party developer for certain utilities, goods, and services furnished to a qualifying contractor or subcontractor.¹⁷ Changes enacted in S.F. 366 allow an individual taxpayer to claim third-party developer tax credits of an S corporation, LLC, partnership, trust or estate electing to have its income taxed directly to individuals, based on the individual taxpayer’s pro rata share of the pass-through entity’s earnings.¹⁸

Changes to PTE withholding requirements and composite returns

Under Iowa law, a PTE historically has been required to withhold and remit taxes on behalf of its nonresident members.¹⁹ However, as an alternative, a PTE could elect, or the Iowa Department of Revenue could require, the filing of an Iowa composite return.²⁰ S.F. 608 amends Iowa law to eliminate the nonresident withholding requirement²¹ and instead mandate the filing of a composite return reporting income and remitting tax on behalf of all nonresident members for tax years beginning on or after Jan. 1, 2022.²² “Nonresident members” include (i) non-resident individuals; (ii) trusts and estates without a situs in Iowa; and (iii) partnerships, C corporations, S corporations and financial institutions without a commercial domicile in Iowa.²³ The Department is provided the authority to allow the income of certain members of PTEs to not be subject to composite return reporting and taxation pursuant to a Department-promulgated rule or issued ruling.²⁴ In addition, the Department may require a composite filing for nonresidents other than nonresident PTE owners if necessary for efficient administration of the income tax.²⁵

Commentary

The omnibus tax legislation contains significant changes with respect to Iowa’s conformity to the IRC. Iowa eliminated any lingering doubt for fiscal year taxpayers by conforming to the federal income tax treatment of forgiven PPP loans, and providing benefit to taxpayers by excluding COVID-19 related grants from taxable income. In an effort both to move Iowa closer to conformity with the IRC and spur potential economic development in the state, state officials chose to conform Iowa to the federal bonus depreciation provisions under IRC Sec. 168(k). Furthermore, Iowa continued with its decision last year to decouple from the IRC Sec. 163(j) provisions. Iowa’s decision to decouple from the IRC Sec. 163(j) limitation retroactive to the 2021 tax year for corporate income tax purposes is a favorable development for Iowa taxpayers, even after Iowa chose to conform to federal bonus depreciation under IRC Sec. 168(k).

By removing the revenue triggers in the contingent provisions of legislation enacted in 2018, Iowa taxpayers are provided with greater certainty that these changes will actually take effect for tax years beginning on or after Jan. 1, 2023, given that the revenues envisioned to be generated by the state did not account for the economic effects of the COVID-19 pandemic. An important change for Iowa corporate taxpayers is the elimination of the Iowa NOL in favor of using federal taxable income after the federal NOL deduction as the starting point for computing Iowa taxable income. Given that the Iowa filing group often does not include all members of the federal consolidated group, the movement away from an Iowa NOL will likely increase the compliance burden for many Iowa taxpayers, especially for those corporate taxpayers having separate-entity losses but recognizing net income on a federal consolidated basis. As a result of this change, Iowa joins Virginia as one of only two states that require or allow corporate taxpayers to file on a separate-entity or nexus consolidated basis, and require the use of a federal NOL in lieu of a state NOL.

Overall, it is anticipated that the omnibus tax legislation will reduce Iowa tax revenues by over $1 billion from fiscal years 2022 through 2027, much of which comes from removing the revenue triggers associated with the contingent changes to the Iowa tax code enacted in 2018.²⁶ With the overhaul to Iowa’s corporate and individual income tax regimes, it remains to be seen the extent to which the decreases in projected Iowa tax revenues resulting from S.F. 619 will impact Iowa’s ability to retain the federal funding being provided through the Coronavirus State Fiscal Recovery Fund established in the American Rescue Plan Act of 2021.²⁷

Finally, S.F. 608 significantly changes the filing requirements for PTEs with nonresident members. Instead of withholding and remitting tax on behalf of such members, PTEs will be required to file a composite return and remit tax at the highest Iowa tax rate starting with the 2022 tax year. One unique aspect of Iowa’s new composite reporting requirement is that it applies not only to members who are nonresident individuals, but also to trusts, estates, partnerships, C corporations, S corporations and financial institutions without a situs or commercial domicile in Iowa. Thus, the applicable Iowa composite tax rate for each nonresident member will depend on whether such member is an individual, trust, estate, tiered partnership or corporation.

1 P.L. 116-136 (2020).
2 P.L. 116-260 (2020).
3 H.F. 2641, Laws 2020; IOWA CODE §§ 422.7.59; 422.35.26. Note that Div. V, § 62 and Div. VIII, § 77 of H.F. 2641 both added a subsection 59 to IOWA CODE § 422.7. For further discussion of this legislation, see GT SALT Alert: Iowa Legislation Amends Corporate Income Tax and Sales Tax Provisions, Including Decoupling from GILTI and Interest Expense Limitation.
4 H.F. 2641, Div. VIII, § 77, adding IOWA CODE § 422.7.59.b.
5 S.F. 619, Div. XVII, §§ 52–54, striking IOWA CODE §§ 422.7.39A; 422.35.19A.
6 S.F. 619, Div. XVIII, §§ 55–57, striking IOWA CODE §§ 422.7.60.b; 422.35.27.b.
7 IOWA CODE § 422.32.1.h(2). “Static” conformity states adopt the IRC as of a specific date and must decide whether to update their conformity through subsequent legislation. In contrast, “rolling” conformity states automatically tie to the IRC as changes are adopted.
8 H.F. 2641, Div. XIV, § 109.
9 S.F. 619, Div. IV, § 9.
10 S.F. 619, Div. III, §§ 5–8, amending IOWA CODE §§ 422.7.62; 422.35.30.
11 Specifically, the law allowed for the enactment of income changes if the state’s net general fund revenue reached $8.3146 billion for the fiscal year ending June 30, 2022 and equaled at least 104% of net general fund revenue for the fiscal year ending June 30, 2021. S.F. 2417, Laws 2018, §§ 99–134. For further discussion of this legislation, see GT SALT Alert: Iowa Enacts Tax Reform Legislation Updating IRC Conformity, Reducing Income Tax Rates, Expanding Sales Tax.
12 S.F. 619, Div. I, § 1, amending S.F. 2417, Laws 2018, § 133.
13 Id.
14 S.F. 619, Div. V, §§ 11–16, adding IOWA CODE § 450.10.7.
15 This 20% reduction is effective retroactively to January 1, 2021. S.F. 619, Div. V, § 16.
16 S.F. 619, Div. V, §§ 11–16, adding IOWA CODE § 450.10.7.
17 IOWA CODE § 15.331C.
18 S.F. 366, Div. I, § 1, amending IOWA CODE § 15.331C.
19 IOWA CODE § 422.16.12.
20 IOWA CODE § 422.13.5.
21 S.F. 608, Div. II, § 12, amending IOWA CODE § 422.16.12.a.
22 S.F. 608, Div. II, § 14, adding IOWA CODE § 422.16B.
23 S.F. 608, Div. II, § 14, adding IOWA CODE § 422.16B.1.a.
24 S.F. 608, Div. II, § 14, adding IOWA CODE § 422.16B.5.c.
25 S.F. 608, Div. II, § 14, adding IOWA CODE § 422.16B.6.
26 Fiscal Note to S.F. 619, Iowa Legislative Service Agency, Fiscal Services Division, May 18, 2021.
27 P.L. 117-2 (2021).

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