The Iowa Legislature adjourned on May 5, 2018, almost three weeks past its scheduled end date. One of the reasons for this longer session was the effort expended on tax reform. As noted in Tax Alert 2018-0399, two study bills were introduced in February addressing tax reform, each with different approaches. The differences were eventually reconciled, culminating in Iowa Senate File 2417 (SF 2417), which was adopted by both houses of the Legislature and is expected to be signed by Governor Kim Reynolds in the near future. SF 2417 makes a number of changes affecting Iowa's corporate, individual and sales/use taxes.

IRC conformity

Iowa currently conforms to the Internal Revenue Code as of January 1, 2015. SF 2417 will update IRC conformity to March 24, 2018, for tax years beginning on or after January 1, 2019. For tax years beginning on or after January 1, 2020, Iowa will become a rolling IRC conformity state, but will continue decoupling from federal bonus depreciation. The changes to the IRC conformity date will apply to both corporate and individual income taxes.

Corporate income taxes

SF 2417 does not provide for any immediate corporate income tax rate reductions. For tax years beginning on or after January 1, 2021, however, the top corporate income tax rate will be reduced from 12% to 9.8% on income over $250,000. The Iowa Alternative Minimum Tax and the ability to deduct federal income taxes will also be eliminated for tax years beginning on or after January 1, 2021.

SF 2417 will also makes changes to certain Iowa economic development incentives. Retroactive to tax years starting on or after January 1, 2017, the Iowa Research Activities Tax Credit will be restricted to businesses in the manufacturing, life sciences, software engineering, or aviation/aerospace industries that claim a federal credit for the same research for the same tax year. SF 2417 enumerates persons who would not be deemed to be engaged in the foregoing activities. SF 2417 will extend the expiration dates of the Innovation Fund Tax Credit program to June 30, 2023, and the Targeted Jobs Pilot Project to June 30, 2019.

Individual income taxes

For tax years beginning on or after January 1, 2019, the top individual income tax rate will be lowered from 8.98% to 8.53%. SF 2417 also provides for future contingent reductions in the individual income tax rates and the number of tax brackets starting in tax years beginning on or after January 1, 2023. These changes will apply only upon two conditions being met: (1) net General Fund revenue must be at least $8.3146 billion in the previous fiscal year; and (2) the net General Refund revenue for the fiscal year described in (1) must exceed the net General Fund revenue for the fiscal year before that.

SF 2417 will also couple with the recent changes to IRC Section 179 as enacted in the Tax Cuts and Jobs Act (P.L. 115-97)(TCJA), increasing the Iowa-specific expensing and investment caps from the present $25,000 and $200,000, respectively to $70,000 and $280,000, respectively for tax years beginning on or after January 1, 2018. For tax years beginning on or after January 1, 2019, the caps will increase to $100,000 and $400,000, respectively. For tax years beginning on or after January 1, 2020, Iowa will fully couple to the federal caps of $1 million and $2.5 million, respectively, with annual indexing. In addition, SF 2417 will allow owners of pass-through entities (partnerships, S corporations, or LLCs taxed as partnerships) to elect to depreciate expensing that is received from the pass-through entity and exceeds the Iowa cap, when each entity cannot exceed the federal cap of 20% per year in the subsequent five years.

SF 2417 will also couple Iowa to the federal modifications of IRC Section 1031 that effectively eliminate the ability to enter into a tax-free like-kind exchange for all but real property for tax years beginning on or after January 1, 2018.

Finally, SF 2417 provides for an Iowa deduction for income from pass-through entities consistent with the new federal Qualified Business Income rules under IRC Section 199A for tax years beginning on or after January 1, 2019. For tax years 2019-20, 25% of the federal deduction will be allowed. For tax year 2021, 50% of the federal deduction will be allowed. For tax year 2022, 75% of the federal deduction will be allowed. For tax years 2023 and forward, 100% of the federal deduction will be allowed if the Iowa General Fund triggers described previously are met.

Sales and use taxes

SF 2417 will make a number of changes to Iowa's sales/use tax laws. SF 2417 will add ride-sharing services, streaming video, video-on-demand and pay-per-view services, photography, information services, video game services and tournaments, online travel services, and software-as-a-service to the enumerated services subject to tax. Digital goods will also be specifically enumerated as taxable.

SF 2417 also narrows the definition of the term "manufacturer" by excluding certain activities from the definition, such as construction contracting, repairs, farming, and others. This change will take effect immediately.

SF 2417 will also require out-of-state sellers to collect tax if they have either $100,000 or more in Iowa sales or 200 or more separate Iowa sales transactions in a calendar year. Tax collection will also be required if the out-of-state seller uses software downloaded on a device used in Iowa (including "cookie nexus") or uses a content distribution network or a marketplace facilitator to generate Iowa sales. If the retailer required to collect and remit tax fails to do so, all affiliates that control (directly, indirectly or constructively) the retailer will be jointly and severally liable for any tax, penalty and interest due, regardless of whether the affiliate is a retailer.

These changes will take effect January 1, 2019, unless otherwise noted.

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