United States

Kansas legislature overrides veto on income tax revenue raisers

TAX ALERT  | 

On June 6, 2017, the Kansas state legislature overrode Gov. Sam Brownback’s veto of Senate Bill 30, a tax bill providing for estimated revenue increases of $1.2 billion over the next two years and the opportunity to close the state’s nearly $900 million budget gap. The highly anticipated legislation rolls back Gov. Brownback’s pass-through entity exemptions originally enacted in 2012, and a subject of constant debate among Kansas legislators, politicians and economists throughout the country.

The repeal of the pass-through exemption

Senate Bill 30 limits certain subtractions to tax years beginning after Dec. 31, 2012, and ending before Jan. 1, 2017. Accordingly, taxpayers are no longer permitted to subtract certain income that is a net profit from a business, certain pass-through entity income and farm income. Specifically, subtractions are prohibited for net profit from business as determined under the federal internal revenue code and reported from schedule C and on line 12 of the taxpayer’s Form 1040 federal individual income tax return; (2) net income, not including guaranteed payments, from rental real estate, royalties, partnerships, S corporations, estates, trusts, residual interest in real estate mortgage investment conduits and net farm rental as determined under the federal internal revenue code and reported from schedule E and on line 17 of the taxpayer’s Form 1040 federal individual income tax return; and (3) net farm profit as determined under the federal internal revenue code and reported from Schedule F and on line 18 of the taxpayer’s Form 1040 federal income tax return.

The repeal of those subtractions for tax years beginning on or after Jan. 1, 2017, repeals the pass-through exemptions that have gained so much attention in the last few years. Additionally, Senate Bill 30 contains a number of addback and other subtraction modifications that taxpayers should review carefully. A selection of those modifications follows:

Addback modifications:

  • Beginning Jan. 1, 2017, taxpayers are no longer required to addback to federal adjusted gross income the amount of any:

o   (1) loss from business as reported from Schedule C and on line 12 of Form 1040, (2) loss from rental real estate, royalties, partnerships, S corporations, except those with wholly owned subsidiaries subject to the Kansas privilege tax, estates, trusts, residual interest in real estate mortgage investment conduits, and (3) farm loss as determined from Schedule F on line 18 of Form 1040

o   deduction for self-employment taxes under section 164(f) to the extent the deduction is attributable to income reported on Schedule C, E or F and on line 12, 17 or 18 of the taxpayer’s Form 1040

o   deduction for pension, profit sharing and annuity plans of self-employed individuals under section 62(a)(6)

o   deduction for health insurance under section 162(l)

o   deduction for domestic production activities under section 199

  • The federal net operating loss deduction is no longer added back to an individual’s federal adjusted gross income for tax years beginning after Dec. 31, 2016.

Subtraction modifications:

  • Beginning Jan. 1, 2017, taxpayers will no longer be permitted to subtract from federal adjusted gross income the amount of any:

o   net gain from the sale of cattle and horses held by the taxpayer for draft, breeding, dairy or sporting purposes and held by such taxpayer for 24 months or more from the age of acquisition, and other livestock held by the taxpayer for 12 months or more from the date of acquisition

o   net gain from the sale from Christmas trees grown in Kansas and held by the taxpayer for six years or more

Personal income tax rate increases, new tax brackets and exclusions

Senate Bill 30 modifies the personal income tax by increasing rates and creating new tax brackets for both married and individual filers, retroactive to Jan. 1, 2017. The following changes were made for married filers for the 2017 tax year:

  • Increases the state income tax rate for married individuals filing joint returns from 2.6 percent to 2.9 percent on taxable income not over $30,000
  • Increases the state income tax rate for married individuals filing joint returns from 4.6 percent to 4.9 percent on taxable income over $30,000, but not over $60,000
  • Creates a new tax bracket for married individuals filing joint returns on taxable income over $60,000 at a rate of 5.2 percent

For single filers, the following changes apply for the 2017 tax year:

  • Increases the state income tax rate for individuals from 2.6 percent to 2.9 percent on taxable income not over $15,000
  • Increases the state income tax rate for individuals from 4.6 percent to 4.9 percent on taxable income over $15,000, but not over $30,000
  • Creates a new tax bracket for individuals with taxable income over $30,000 at a rate of 5.2 percent

Additional rate increases are scheduled for both married and individual filers for the 2018 tax year and thereafter.

Senate Bill 30 also makes changes to the excluded income thresholds. For tax years 2016 and 2017, married individuals filing joint returns with taxable income of $12,500 or less, and all other individuals with taxable income of $5,000 or less will have no tax liability. For tax years 2018 and after, married individuals filing joint returns with taxable income of $5,000 or less, and all other individuals with taxable income of $2,500 or less will have no tax liability.

Changes to itemized deductions

Senate Bill 30 includes a number of modifications to itemized deductions. Itemized deductions for mortgage interest, taxes on real and personal property, and medical expenses, are allowed at 50 percent of the federal amount in 2018, 75 percent in 2019 and then 100 percent in 2020 and thereafter.

Child-care tax credit

Senate Bill 30 phases in a child-care tax credit at 12.5 percent in 2018, 18.75 percent in 2019 and 25 percent in 2020 and thereafter.

Takeaways

Importantly, Senate Bill 30 provides that taxpayers will not be assessed penalties and interest arising from the underpayment of taxes due to changes to the tax rates and additions and subtractions, including the repeal of the pass-through exemption, that become law on July 1, 2017, as long as such underpayment is rectified on or before April 17, 2018.

Individuals and owners of pass-through entities should evaluate the impact of these changes on their current and ongoing Kansas tax liabilities. Senate Bill 30 makes a number of modifications to additions and subtractions, essentially limiting the 2012 tax legislation to before Jan. 1, 2017. The changes will have a significant impact on state tax revenues and businesses should continue to be aware of further changes and administrative guidance pursuant to the changes. Kansas taxpayers impacted by the changes should reach out to their tax advisors, especially considering the number of changes effective beginning in 2017.

For more information regarding Kansas tax reform efforts, please see our prior article, Kansas state legislature fails to override governor's veto of tax bill.

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