Iowa enacts major tax reform package with reduced tax rates

On March 1, 2022, Iowa Gov. Kim Reynolds signed into law House File 2317, making significant changes to the state’s tax code following several years of major tax reform legislation. Passing with significant support in both chambers, the bill addresses a reduction in personal income tax rates, a procedure to reduce corporate income tax rates under certain fiscal conditions and numerous other taxpayer-friendly changes. A highlighted summary of the changes follows below. 

Personal and corporate income tax rate changes

Personal income tax

The legislation significantly alters the personal income tax rates beginning Jan. 1, 2023. Currently, for tax years beginning prior to Jan. 1, 2023, there are nine tax brackets with the highest marginal rate of 8.53%. Those brackets were scheduled to be reduced to four with a highest marginal tax rate of 6.5% beginning Jan. 1, 2023. However, House File 2317 amends the rates for the four brackets, reduces the number of brackets over the next four tax years and schedules a phase-in of a flat 3.9% tax rate. Accordingly, the tax rates and brackets beginning in 2023 through 2025 are scheduled as follows:

The 3.9% flat rate will be fully phased-in for all filers beginning for 2026 tax years and after. 

Corporate tax

For 2022, the state uses three tax brackets for its corporate tax as follows: 5.5% for corporate income up to $100,000; 9% for income between $100,000 and $250,000; and 9.8% for income over $250,000. The legislation creates a system to reduce the corporate rate over a period of years, and ultimately resulting in a single rate, when the state generates in excess of $700 million in corporate income tax receipts, effective beginning for tax year 2023.

The process of reducing the corporate tax to a single rate is as follows: for each preceding fiscal year that the state generates in excess of $700 million, the Iowa Department of Revenue will calculate the top marginal tax rate which would have generated exactly $700 million in receipts in that year. The result of the calculation will yield a percentage that will be used to reduce the top tax rate for the upcoming year. This calculation will take place at the conclusion of each fiscal year until the Iowa corporate income tax rate is lowered to a single rate of 5.50%, the lowest current marginal corporate income tax rate. No adjustment is made if the state generates under $700 million in corporate income tax receipts. 

Retirement income 

House File 2317 also excludes certain retirement income beginning in 2023 as follows:

Retirement income exemption: Beginning in tax year 2023, disabled Iowans, or those age 55 and older, are able to exclude from taxable income certain retirement income received from a governmental or other pension or retirement plan, including defined benefit or defined contribution plans, annuities, individual retirement accounts, plans maintained or contributed to by an employer, or maintained or contributed to by a self-employed person as an employer, and deferred compensation plans or any earning attributed to the deferred compensation plans.   

Farmer retirement income exemption: Beginning in tax year 2023, an Iowa farmer that is disabled or age 55 and older who farmed for at least 10 years but has retired from farming operations, can elect an exemption of income received from a farm tenancy agreement on property the farmer owned for 10 or more years, for all years the income is earned:

1. Farm tenancy agreement includes cash leases, crop share leases or livestock share leases.
2. This exclusion is not available if the farm tenancy agreement is owned by a partnership or S-Corporation, even if the income passes to an individual partner or shareholder.

Capital gain exclusions

Qualified stock sale exclusion

House File 2317 provides that an employee-owner is entitled to make one irrevocable lifetime election to exclude the net capital gain from the sale or exchange of capital stock of one qualified corporation which capital stock was acquired by the employee-owner while employed and on account of employment by the corporation. A qualified corporation must have employed individuals in the state for a minimum of 10 years, must have had at least five shareholders for 10 years prior to the first sale or exchange and the corporation has to have had at least two shareholders or group of shareholders who are not related, under section 318, for the 10 years prior to the first sale or exchange. An employee-owner is an individual who owns capital stock in a qualified corporation for at least 10 years. The election applies to all subsequent sales or exchanges of qualifying capital stock within 15 years of the date of the election. The deduction is phased-in over three years as follows: 33% in 2023, 66% in 2024, and 100% in 2025 and after. 

Farm capital gain exclusion

The bill allows retired farmers to elect one, lifetime election, to exclude the net capital gains from the sale of farm property, including real property and certain livestock. This election repeals the existing capital gains deduction related to certain farm assets. Eligible taxpayers should carefully review the numerous requirements. 

Credits and incentives

The legislation makes numerous changes to the state’s research activities credit including requiring the use of the alternative simplified method of credit calculation if that method was used for federal purposes, disallows certain supplies and computer expenses and reduces tax credit refundability.

The bill also makes changes to other credits and incentives, including reducing the refundability of the following credits by five percentage points until capping at 75% refundability for tax years beginning after Jan. 1, 2027:

• Redevelopment tax credit
• Historic preservation tax credit
• Third-party developer tax credit
• Assistive device tax credit 

Takeaways

Tax reform has remained a significant component of the Reynold’s administration, with the latest legislation coming in as at least the third major tax reform bill enacted in recent years. The reduced refundability will slightly increase tax revenue over the next five fiscal years, but the personal and corporate income tax rate changes will significantly reduce revenue by up almost $2 billion per year by the 2028 fiscal year. However, Iowa continues to experience strong sales tax collections coming out of the pandemic, partly attributed to expanded economic nexus. 

Iowa taxpayers are encouraged to discuss these changes with their state and local tax professional for more information.