There are many elements of the House’s proposed Tax Cuts and Jobs Act that impact state tax revenues given the close linkage between federal and state personal and corporate income taxes. Below are some identified sections of the House’s bill that states will need to analyze to understand the financial implications to their state revenues, and to consider the range of state conformity actions they will choose to legislate, if enacted by Congress. Some state tax codes automatically conform to federal tax law changes unless they choose to specifically decouple through legislation. Other states conform to the federal tax code on a fixed date; in this instance, federal tax law changes are not automatically conformed to by those states.
For reference: Committee on Ways and Means, Tax Cuts & Jobs Act, Section-by-Section Summary
Impacts to State Revenue
This list is not exhaustive, but reflects a first look at the initial bill’s provisions that could impact state revenues.
Personal Income Tax – Changes to Adjusted Gross Income
Most of the 41 states and the District of Columbia that have a broad-based personal income tax use the federal Adjusted Gross Income (AGI) as the starting point for determining state personal income tax liability. A few states use Federal Taxable Income (FTI), and a few have no specific link to either.
The House bill repeals a number of items that mostly increase the amount of AGI. These are referred to as above the line deductions:
- Alimony received and paid (section 1309, 1040 form, lines 11 and 31a)
- Moving expenses (section 1310, 1040 line 26)
- Student loan interest deduction (section 1204, 1040 line 33)
- Tuition and fees (section 1204, 1040 line 34)
- Domestic production activities (section 1309, 1040 line 35)
- Limitations to certain trade and business expenses of being an employee (section 1312, 1040 line 24)
Personal Income Tax - Income Exclusions – New Limitations or Repeals
Subtitle E of the bill addresses changes in income that are currently excluded from taxable income. Most of these changes would also increase AGI:
- Employer-provided housing – new limit (section 1401)
- Gain from sale of principal residence – new limit (section 1402)
- Employee achievement awards – repeal (section 1403)
- Dependent care assistance programs – repeal (section 1404)
- Qualified moving expense – repeal (section 1404)
- Adoption assistance programs – repeal section (1404)
Personal Income Tax – Changes to Taxable Income
For the few states that tie their personal income tax liability to federal taxable income instead of AGI, there are major changes proposed that will significantly modify the computation of taxable income:
- The elimination of the personal exemptions ($4,050 per individual in the 2016 tax year)
- Near-doubling of the standard deduction
- Repeal of certain itemized deductions: medical and dental expenses, state and local taxes except property taxes (limited to $10,000), personal casualty losses, tax preparation expenses, adjustment to AGI limitations on charitable cash contributions
- Repeal of the Alternative Minimum Tax
- Increase in the Child Care tax credit
- New family tax credit – temporary - $300 per person for non-child dependents and for each taxpayer and spouse in the case of a joint return
Corporate Income Tax – Changes to Federal Tax Liability
Most states start the computation of state corporate tax income with federal taxable income. However, states do not conform to federal corporate income tax rates. According to the Tax Policy Center, 44 states levy a corporate income tax. The House bill includes a long list of limitations and eliminations of deductions, exclusions and credits. The most common impact of these changes would increase taxable income. States will have to consider the level of conformity they want in reviewing how these provisions would impact their state tax codes.
- Expensing deduction – broader provisions, but not permanent (section 3101)
- Interest deduction – new limits with exemption of certain small businesses, disallowing net interest expense in excess of 30 percent of the business’ adjusted taxable income (sections 3203 and 3301)
- Net operating loss – new limits (section 3302)
- Deduction for income attributable to domestic production activities – repealed (section 3306)
- Repeal or limitations to other deductions (Subtitle D, sections 3307-3313)
- Repeal or limitations to business credits (Subtitle E)
Other Provisions Where Some States Link to the Federal Tax Code
There are a number of other federal tax code elements that states use as a starting point within their own tax code or add state tax credit enhancements based on a federal tax credit. The estate tax is one where states that impose it use the federal estate tax value as a starting point but may differ in permitted exemptions. The House’s bill proposes to eliminate the federal estate tax after 2023.
Impact on State Spending/Debt Issuance
There is one provision that impacts state spending, a section that repeals the most used tax-exempt debt refinancing tool, advance refunding bonds.
Tax-Exempt Debt Refinancing Repeal – Advance Refunding Bonds (section 3602 of the bill)
Advance refunding bonds are used by state and local governments to obtain the benefit of lower interest rates when the outstanding bonds are not currently callable. The House bill eliminates advance refunding of tax-exempt debt. Based on an article from Bloomberg, advance refundings represent one-quarter to one-third of yearly tax-exempt municipal debt issuance. This is a significant tool that states use to manage their debt programs. States use this tool to take advantage of lower interest rates, increase their debt capacity, and free up resources for infrastructure and other priorities. This change is estimated to increase federal tax revenues by $17.3 billion over ten years.
Private Activity Bonds Repealed (section 3601 of the bill)
Private activity bonds have been used to attract private investment for projects that have some public benefit. They are revenue backed bonds issued by a state or local authority on behalf of a private project. They must meet certain qualifications to be tax-exempt. They have been used for airports, low-income housing, student loans, hospitals and major infrastructure projects, such as toll roads and bridges. The tax exemption, within volume cap limits allocated to states, have reduced the cost of capital for eligible projects. According to the Council of Development Finance Agencies, states issued $13.1 billion in private activity bonds in 2015.
Tax-Exempt Bonds for Professional Sports Stadiums Repealed (section 3603 of the bill)