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Jamie C. Yesnowitz
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On May 30, 2018, Iowa Gov. Kim Reynolds signed legislation, S.F. 2417, which provides major tax reform.1
Under S.F. 2417, Iowa’s individual income tax rates will be immediately reduced, corporate income tax rates will be reduced beginning in 2020, the income tax law is conformed to recent federal income tax changes generally beginning in 2019, and the sales tax is expanded to include many digital and online computer services, along with an aggressive expansion of Iowa’s sales tax nexus provisions.
IRC conformity addressed
Under existing law, for the 2017 and 2018 tax years, the Internal Revenue Code (IRC) as it existed on Jan. 1, 2015, is used.2
For tax years beginning in 2019, the legislation provides that Iowa’s income tax will be based on the IRC as it existed on March 24, 2018.3
As a result, Iowa will generally conform to the federal tax reform provisions contained in H.R. 1, commonly referred to as the Tax Cuts and Jobs Act (TCJA).4
For tax years beginning on or after Jan. 1, 2020, the legislation provides that Iowa income tax law will be based on the IRC as currently amended.5
With respect to provisions involving international transactions, Iowa historically has allowed a subtraction for foreign dividend income, including subpart F income defined by IRC Sec. 952, received by a corporation.6
A 100% subtraction is allowed of this income if at least 80% of the stock is owned by the recipient corporation (with lesser percentage subtractions available if lower ownership percentage thresholds are met pursuant to IRC Sec. 243).7
As a result, the legislation does not contain provisions concerning the treatment of deemed repatriation income under IRC Sec. 965 or global intangible low-taxed income (GILTI) under IRC Sec. 951A since these income items should qualify for a full subtraction to the extent the 80% ownership threshold is met. With the adoption of the updated provisions of the IRC for tax years after 2018, Iowa will conform to the deduction allowed under IRC Sec. 250 for foreign derived intangible income (FDII).
As for other TCJA provisions, the interest expense limitation rules contained in IRC Sec. 163(j) will be adopted for tax years beginning in 2019 and thereafter. However, Iowa has its own state-specific net operating loss (NOL) provisions8
that do not specifically tie to federal NOL concepts (for example, the Iowa NOL allows farmers to carry back NOLs for five years).9
Also, Iowa continues to decouple from bonus depreciation.10
In addition, under the legislation, TCJA provisions which increased the size of small businesses that can use the cash method of accounting, provisions determining the year for inclusion of income, and provisions dealing with S to C corporation conversions were adopted retroactively to tax years beginning on or after Jan. 1, 2018.11
IRC Sec. 179 increased expense allowance
For corporate income tax purposes, the increased expensing allowance under IRC Sec. 179 applies in Iowa for tax years beginning in 2019 and thereafter, but certain limitations apply for the 2019 tax year.12
If a taxpayer takes the increased expensing allowance during the 2019 tax year, the taxpayer must: (i) add the total amount of expense deduction taken under IRC Sec. 179; and (ii) subtract the amount of expense deduction allowable under IRC Sec. 179, not to exceed $100,000.13
Certain taxpayers may elect to use a special computation if their expensing allowance deduction is allocated from partnerships or limited liability companies electing to have the income taxed directly to the owners. 14
For individual income tax purposes, the increased expensing allowance under IRC Sec. 179 applies for tax years beginning on or after Jan. 1, 2018, but certain limitations apply for the 2018 and 2019 tax years.15
If a taxpayer takes the increased expensing allowance during the 2018 or 2019 tax years, the taxpayer must: (i) add the total amount of expense deduction taken under IRC Sec. 179; and (ii) subtract the amount of expense deduction allowable under IRC Sec. 179, not to exceed $70,000 for the 2018 tax year and $100,000 for the 2019 tax year.16
A special computation is available for certain taxpayers if their expensing allowance deduction is allocated from partnerships, S corporations or limited liability companies electing to have the income taxed directly to the individual taxpayer.17
Corporate income tax rate reduction
Budgetary reasons caused the General Assembly to delay the corporate income tax rate reduction until tax years beginning in 2021 and thereafter, reducing the top corporate income tax rate (applicable for taxable income of $250,000 or more) from 12% to 9.8%.18
Also, beginning with the 2021 tax year, the Iowa corporate alternative minimum tax (AMT) is repealed. 19
The credit for the prior year’s AMT amounts will be allowed as a carryover only for the 2021 tax year.20
For tax years beginning prior to 2021, existing law provides that an amount equal to 50% of the federal income taxes that were paid is allowed as a deduction.21
In conjunction with the reduction in the corporate tax rates and beginning in 2021, the deduction allowed for federal income taxes is repealed.22
Individual income tax rate reduction
Beginning in 2019, the top individual income tax rate (applicable for taxable income exceeding $45,000) will be reduced from 8.98% to 8.53%.23
If certain revenue targets are satisfied, the legislation contains provisions to reduce the top individual income tax rate (applicable for taxable income exceeding $75,000) to 6.5 percent beginning in 2023.24
IRC Sec. 199A: pass-through entity deduction
Unlike most states that have completely decoupled from the IRC Sec. 199A pass-through entity deduction enacted by the TCJA, Iowa plans to allow a partial deduction that is intended to increase over time.25
During 2019 and 2020, 25% of the deduction will be allowed. During 2021, 50% of the deduction will be allowed, and beginning in 2022, 75% of the deduction will be allowed. If revenue targets are met and the individual income tax rates are reduced, beginning in 2023 the starting point for the individual income tax will be changed to federal taxable income and the entire pass-through deduction will be allowed.
Note that the number of tax brackets would be reduced. Under current law, there are nine different tax brackets. If the revenue targets are met, there will be four different brackets. Also, current law provides a single bracket schedule that does not distinguish between filing status. If the revenue targets are met, there will be a bracket schedule for married couples filing jointly and a separate schedule that applies to all other taxpayers.
Applicable retroactively to tax years beginning on or after Jan. 1, 2017, the legislation limits the research credit to companies engaged in manufacturing, life sciences, software engineering, or the aviation and aerospace industry.26
In addition, in order to qualify to receive the Iowa research credit, the business must have claimed and been allowed the research credit for federal income tax purposes during the same year.
The legislation also contains a specific definition of base amount for purposes of computing the research credit.27
In no event can the base amount be less than 50% of the qualified research expenses for the credit year. While this provision is effective upon enactment, the General Assembly also added a statement providing that this change is consistent with current state law and that the amendment does not change current law, but that it instead reflects current law both before and after the change. 28
Sales and use tax
Tax base expansion
Effective Jan. 1, 2019, electronically transferred specified digital products will become subject to sales tax.29
These specified digital products include digital audio-visual works such as movies, digital audio works, digital books, greeting cards, images, video or electronic games or entertainment, news or information products, and computer software applications.30
Also on Jan. 1, 2019, the following services will become subject to tax:
- Photography and retouching;
- Software as a service;
- Video game services and tournaments;
- Services related to installing, operating, or enhancing specified digital products;
- Information services, which means providing access to databases or subscriptions to information through any tangible or electronic medium; and
- Storage of tangible or electronic documents or records.31
However, the sale of these digital products or these newly taxed services, including the sale of prewritten computer software, to a commercial business (including a professional business) is exempt if the product or service is used exclusively by the business.32
Starting Jan. 1, 2019, the legislation extends Iowa’s sales tax collection responsibilities to any retailer who has Iowa sales of at least $100,000, or at least 200 separate transactions during the prior or current calendar year.33
Retailers also have sales tax nexus if they make Iowa sales through the use of a solicitor and have Iowa sales exceeding $10,000 for the prior or current calendar year.34
The legislation also extends sales tax nexus to marketplace facilitators and referrers.35
Specifically, marketplace facilitators who process payments on behalf of marketplace sellers will be required to collect sales tax on behalf of their sellers, provided the facilitator made Iowa sales on behalf of its sellers of at least $100,000, or at least 200 separate transactions during the prior or current calendar year.36
Referrers must collect sales tax if, during the prior or current calendar year, they have at least $100,000 in Iowa sales or at least 200 separate Iowa transactions resulting from referrals from a platform of the referrer.37
A retailer who makes at least $100,000 of sales to Iowa customers during the prior or current calendar year and who installs software or data files on property used in Iowa is deemed to have nexus for sales tax purposes.38
The law defines the software or data files to include software that is downloaded as a result of the use of a Web site and includes cookies. Also, this sales tax nexus extends to: (i) a retailer that uses in-state software to make Iowa sales; and (ii) a retailer that provides, or enters into an agreement with another person to provide, a content distribution network in Iowa to facilitate, accelerate or enhance the delivery of the retailer’s Internet site to purchasers. 39
In addition, the law provides authority to the Department to adopt rules requiring retailers who do not collect the sales tax to notify their customers of their requirement to pay Iowa use tax, provide purchasers with periodic reports about the amount of their purchases, and to also provide these reports to the Department. 40
No class action tax litigation
The legislation enacts a prohibition on class action tax litigation that may be brought against the Department or a taxpayer or person who is required to collect any tax based on any act or omission related to any provision of the tax laws.41
Also, the legislation includes a ban on bringing a private cause of action against any person required to collect sales tax alleging that the person has overpaid the taxes as long as the sales tax amounts have been remitted to the Department.42
A taxpayer who has overpaid sales taxes to the Department may still bring an action to secure a refund of the sales tax amounts which it overpaid.43
These provisions, which are effective upon enactment,44
are intended to endorse the result in Bass v. J.C. Penney Co., Inc.,45
in which the Iowa Supreme Court held that an individual could not bring a class action suit against a retailer based on wrongful collection of sales tax.
Given budgetary constraints, S.F. 2417 eventually will conform to the provisions of the TCJA following a delay. As a result, the nonconformity to the various TCJA provisions for the 2018 tax year will cause significant differences in how the Iowa income tax is calculated, since Iowa’s income tax law will continue to be based on the IRC as it existed on Jan. 1, 2015. At this point, it is not clear how Iowa will address some of the international provisions contained in the TCJA. Iowa will not conform to the IRC Sec. 965 repatriation provisions, but conformity to GILTI and FDII will become an issue beginning in 2019 when Iowa generally conforms to the IRC. Because GILTI may not be classified as subpart F income or a dividend, it is possible that taxpayers will not be able to deduct this income without further state action.
The budgetary concerns that have given rise to delayed conformity to the TCJA also caused the General Assembly to delay the Iowa individual and corporate income tax rate reductions, and the elimination of the Iowa corporate AMT. By the same token, the legislation is designed to avoid over-collection of revenues, so that if Iowa’s budget situation improves and revenue targets are reached, more dramatic tax cuts for businesses and individuals could result.
Significant changes were made to Iowa’s sales tax law.46
Not only did the state adopt aggressive economic nexus thresholds, it also enacted a provision to take the position that nexus is established if software or data files such as cookies are installed on property used in Iowa. The state’s economic nexus statute that applies to remote sellers is very similar to the South Dakota statute that currently is being considered by the U.S. Supreme Court in Wayfair
Thus, the constitutionality of this statute will not be known until the Court soon issues its decision. In addition, Iowa will impose its sales tax on selected digital products, along with software as a service, and information services. It is important to note that the law was amended to continue to exempt these purchases when made by businesses for business purposes.
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