Iowa reduces corporate, individual income tax rates

 

On March 1, 2022, Iowa Gov. Kim Reynolds approved significant tax legislation (H.F. 2317) that reduces the state’s corporate income tax rate contingent upon future revenue targets being satisfied; phases in reductions to Iowa’s individual income tax rate; and modifies the taxability of certain income received by retirees and farmers.1 The legislation also significantly changes both the calculation of and timing for claiming the Iowa research activities credit (Iowa RAC).

 

 

 

Corporate income tax changes

 

Beginning with the 2023 tax year, H.F. 2317 provides that Iowa’s top two graduated corporate income tax rates will be reduced contingent upon the state’s corporate income tax receipts for the preceding fiscal year exceeding $700 million.2

Under the legislation, Iowa’s corporate income tax for the 2021 and 2022 tax years is imposed at the following graduated rates:

  • 5.5% on a taxpayer’s first $100,000 of Iowa taxable income;
  • 9.0% on Iowa taxable income between $100,001 and $250,000; and
  • 9.8% on Iowa taxable income over $250,000.3


By Nov. 1, 2022, and every Nov. 1 thereafter (defined in the legislation as the “determination date”), the Iowa Department of Management must determine the Iowa net corporate income tax receipts for the preceding fiscal year.4 If such receipts exceed $700 million, the Iowa Department of Revenue (Department of Revenue) is required to adjust the corporate income tax rates based on the rates that would have generated $700 million of Iowa net corporate income tax receipts in the preceding fiscal year.5 These new rates, rounded to the nearest 0.1%, are then applied to the tax year beginning on or after the January 1 following the applicable determination date.6 Such corporate income tax rate reductions cannot result in a tax rate below 5.5%.7 Once such annual rate reductions results in a flat corporate income tax rate of 5.5%, Iowa’s corporate income tax rate will remain at 5.5% for all subsequent tax years.8

 

 

 

Iowa RAC changes

 

Prior to the enactment of H.F. 2317, Iowa’s RAC provided a refundable credit equal to 6.5% of a taxpayer’s increasing qualified research expenditures (QREs) in Iowa. The calculation of QREs conformed with the federal research tax credit under IRC Sec. 41.9

As detailed below, H.F. 2317 makes significant changes to the Iowa RAC for the 2023 tax year and after:

  1. Wage QREs:
    1. For employee wages to be included as Iowa QREs, the majority of the services performed by that employee during the taxable year must be directly related to one or more qualifying research projects.10
    2. For wages paid for qualified research services performed by the employee of a third party on behalf of the taxpayer, the majority of the services performed by that employee for the third party must be directly related to one or more qualifying research projects.11
    3. The “substantially all” rule under IRC Sec. 41(b)(2)(B) for determining qualified services no longer applies.12
  2. Supplies QREs: Beginning with the 2023 tax year, a taxpayer’s supplies, as defined under IRC Sec. 41(b)(2)(C), are included in the Iowa QRE computation as follows:
    1. 2023 tax year: 80% of supplies directly related to Iowa qualified research activities;
    2. 2024 tax year: 60%;
    3. 2025 tax year: 40%;
    4. 2026 tax year: 20%;
    5. 2027 tax year and after: Supplies as defined under IRC Sec. 41(b)(2)(C) will no longer be considered Iowa QREs.13
  3. QREs related to the right to use computers: Amounts paid to another person for the right to use computers to conduct qualified research activities as described under IRC Sec. 41(b)(2)(A)(iii) will no longer constitute Iowa QREs beginning with the 2023 tax year.14
  4. Alternative simplified credit: A taxpayer that elects into or is required to use the alternative simplified credit regime under IRC Sec. 41(c)(4) for its federal research credit will be required to compute its Iowa RAC in the same manner.15 Previously, an Iowa taxpayer could elect to utilize the alternative simplified calculation for its Iowa RAC regardless of whether it made such an election or was required to use this regime for federal purposes.16
  5. Refundability: Beginning with the 2023 tax year, a taxpayer’s excess Iowa RAC becomes partially refundable, and such refundable credits may be applied to the taxpayer’s Iowa tax liability for the subsequent tax year:
    1. 2023 tax year: 90% of a taxpayer’s Iowa RAC in excess of its Iowa income tax liability after non-refundable credits is refundable;
    2. 2024 tax year: 80%;
    3. 2025 tax year: 70%;
    4. 2026 tax year: 60%;
    5. 2027 tax year and after: 50%.17
  6. Timing: Taxpayers must timely file its Iowa income tax return to claim the Iowa RAC. Once this timely filed original return is submitted, taxpayers cannot increase the amount of Iowa RAC claimed for the tax year unless: (i) an amended return is filed within six months of the due date for filing their Iowa income tax return (including extensions); or (ii) the increase results from an IRS or Department of Revenue audit.18

 

 

 

Decreased refundability for other Iowa tax credits

 

Under H.F. 2317, four fully refundable Iowa tax credits will become partially refundable beginning with the credits generated during the 2023 tax year. The excess credits for the following four tax credits will decrease to 95% in the 2023 tax year, 90% in 2024, 85% in 2025, 80% in 2026, and 75% in 2027 and after:

  • Assistive Device Tax Credit;19
  • Historic Preservation Tax Credit;20
  • Redevelopment Tax Credit;21 and
  • Third-party Developer Tax Credit.22

 

 

 

Individual income tax changes

 

 

Reduction in individual tax rates

 

Under current law, Iowa imposes a graduated individual income tax with nine tax brackets and a top marginal tax rate of 8.53%.23 Under H.F. 2317, Iowa will adjust its tax brackets and top marginal tax rate beginning with the 2023 tax year as follows:24

 

 

 

 

Exemption of certain retirement income

 

Beginning with the 2023 tax year, H.F. 2317 provides that Iowa individual taxpayers who are either disabled or at least 55 years of age may exclude from their Iowa taxable income the following categories of retirement income:

  • Defined benefit or defined contribution retirement plans;
  • Annuities;
  • Individual retirement accounts (IRAs);
  • Retirement plans maintained or contributed to by an employer;
  • Retirement plans maintained or contributed to by a self-employed person as an employer; and
  • Deferred compensation plans or any earnings attributable to deferred compensation plans.25


Furthermore, H.F. 2317 provides Iowa farmers an election to exclude farm tenancy income beginning in 2023 if the farmer: (i) farmed for at least 10 years; (ii) has retired from farming operations; and (iii) is either disabled or at least 55 years old.26 This exclusion does not apply to a farm tenancy agreement owned by an S corporation or partnership, even if the farm tenancy income flows through to an eligible individual shareholder or partner.27 Individuals who make this election are prohibited from taking a capital gain exclusion under Iowa Code Sec. 422.7.21, or a beginning farmer tax credit under Iowa Code Sec. 422.11E, in any tax year following the year in which the election is made.28

 

 

Capital gain exclusions

 

Under H.F. 2317, an employee-owner of a qualified corporation who acquired stock in such corporation on account of being employed by that same corporation will be allowed a one-time, irrevocable election to exclude the net capital gains on the sale or exchange of such stock.29 The employee-owner must be an individual who has owned stock in the qualified corporation for at least 10 years.30 This election applies to all subsequent sales or exchanges of stock in the qualified corporation made within 15 years of the election date.31 The deduction is phased in at 33% for the 2023 tax year, 66% for the 2024 tax year, and 100% for the 2025 tax year and after.32

Effective for tax years beginning on or after Jan. 1, 2023, the legislation repeals Iowa’s existing capital gains deduction for qualifying farm assets.33 In its place, H.F. 2317 provides a retired farmer one lifetime election to exclude from Iowa taxable income the net capital gains resulting from the sale of farm property, including qualifying livestock and real property.34

 

 

 

Commentary

 

In recent years, the Iowa legislature has taken its time in crafting and debating significant tax legislation, typically waiting until between late April and mid-June of each legislative session to pass such bills. The 2022 legislative session has been an uncommon departure from this timeline.

On the evening of March 1, 2022, Gov. Reynolds delivered the Republican Party’s response to President Joe Biden’s State of the Union Address. In this speech, the governor announced that she had signed H.F. 2317 into law earlier that day, highlighting her state’s efforts to reduce the corporate and individual tax rates in Iowa, and exclude certain retiree income from Iowa’s income tax.

While the reduction to the Iowa individual and corporate income tax rates is a welcome continuation of Iowa’s recent efforts to reduce the income tax burden on Iowa taxpayers, the uncertainty surrounding the corporate income tax rate reductions adds further complexity for corporate taxpayers. Based on current projections, Iowa’s corporate income tax rate will reach a 5.5% flat rate in approximately 10 years. Iowa corporate taxpayers should monitor the annual tax rate reduction guidance issued by the Department of Revenue ahead of preparing their quarterly or annual financial statements, and prior to remitting any estimated or extension payments.

The changes to the Iowa RAC could potentially chill future investment in Iowa on qualified research activities and could result in certain Iowa taxpayers moving their Iowa research activities to neighboring states. Removing supplies and computer usage QREs from the Iowa RAC computation is a significant departure from the federal research and development credit computation under IRC Sec. 41, and H.F. 2317 is unclear as to whether such QREs are excluded from the computation for the base years. Further, requiring that employees spend at least half of their time on qualified research projects further complicates matters, particularly when gathering the information necessary to support both federal and Iowa QREs. The change to wage QREs, along with limiting the time by which a taxpayer may claim an Iowa RAC to six months after the extended due date of a timely filed return, will require both taxpayers and tax practitioners to modify both their approach and timeline for gathering and analyzing the requisite data to substantiate both federal and Iowa research credit claims.

With several weeks remaining in Iowa’s 2022 legislative session, Iowa taxpayers are encouraged to continue monitoring the tax bills working their way through the state legislature.

 

 

 


1 H.F. 2317, Laws 2022.
2 H.F. 2317, Div. IX, § 56, amending IOWA CODE § 422.33.1.
3 H.F. 2317, Div. IX, § 56, amending IOWA CODE § 422.33.1.a.
4 H.F. 2317, Div. IX, § 56, amending IOWA CODE § 422.33.1.b(1)(b).
5 Id.
6 H.F. 2317, Div. IX, § 56, amending IOWA CODE § 422.33.1.b(2).
7 H.F. 2317, Div. IX, § 56, adding IOWA CODE § 422.33.1.b(2)(b)(iii).
8 H.F. 2317, Div. X, § 57, amending IOWA CODE § 422.33.1; §§ 58, 59, effective contingent upon the rate reductions under H.F. 2317, Div. IX, § 56 reaching 5.5%.
9 IOWA CODE § 422.10.
10 H.F. 2317, Div. VII, § 38, adding IOWA CODE § 422.33.5.b(2)(a)(i).
11 H.F. 2317, Div. VII, § 38, adding IOWA CODE § 422.33.5.b(2)(a)(ii).
12 H.F. 2317, Div. VII, § 38, adding IOWA CODE § 422.33.5.b(2)(b).
13 H.F. 2317, Div. VII, § 38, adding IOWA CODE § 422.33.5.b(2)(d), (e).
14 H.F. 2317, Div. VII, § 38, adding IOWA CODE § 422.33.5.b(2)(c).
15 H.F. 2317, Div. VII, § 35, amending IOWA CODE § 422.10.1.c.
16 IOWA CODE § 422.10.1.c. As enacted, H.F. 2317 does not provide for a carryforward period for the nonrefundable portion of a taxpayer’s Iowa RAC.
17 H.F. 2317, Div. VII, § 37, amending IOWA CODE § 422.10.4.
18 H.F. 2317, Div. VII, § 40, adding IOWA CODE § 422.33.5.e(3).
19 H.F. 2317, Div. VIII, § 52, amending IOWA CODE § 422.33.9.a.
20 H.F. 2317, Div. VIII, § 50, amending IOWA CODE § 404A.2.
21 H.F. 2317, Div. VIII, § 46, amending IOWA CODE § 15.293A.1.c(2).
22 H.F. 2317, Div. VIII, § 49, amending IOWA CODE § 15.331C.1.
23 IOWA CODE § 422.5A.
24 H.F. 2317, Div. IV, § 15, amending IOWA CODE § 422.5A; Div. V, § 20, amending IOWA CODE § 422.5.1.a.
25 H.F. 2317, Div. IV, § 27, amending IOWA CODE § 422.7.31.
26 H.F. 2317, Div. II, § 4, adding IOWA CODE § 422.7.21A.
27 H.F. 2317, Div. II, § 4, adding IOWA CODE § 422.7.21A.e.
28 H.F. 2317, Div. II, § 4, adding IOWA CODE § 422.7.21A.b.
29 H.F. 2317, Div. I, § 1, adding IOWA CODE § 422.7.63.b(1).
30 H.F. 2317, Div. I, § 1, adding IOWA CODE § 422.7.63.c(2).
31 H.F. 2317, Div. I, § 1, adding IOWA CODE § 422.7.63.b(2).
32 H.F. 2317, Div. I, § 1, adding IOWA CODE § 422.7.63.a.
33 H.F. 2317, Div. III, § 7, amending IOWA CODE § 422.7.21; Div. III, § 11.
34 H.F. 2317, Div. III, § 7, amending IOWA CODE § 422.7.21.

 

 

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