June 1, 2021
Iowa legislature approves significant income tax changes, including coupling to federal bonus depreciation, with continued decoupling from limitations on business interest expense
The Iowa Legislature recently adjourned its 2021 legislative session. Before adjourning, the Legislature passed Senate File 619 (SF 619), which would modify Iowa's income tax laws. Governor Kim Reynolds is expected to sign the legislation in the coming days. This Tax Alert discusses the more significant income tax law changes contained in the legislation.
Bonus depreciation and business interest deduction
Iowa has historically decoupled from federal bonus depreciation.1 SF 619 would couple Iowa tax law with federal bonus depreciation for qualified assets purchased on or after January 1, 2021. As discussed later, Iowa's statutory definition of "net income" would be modified starting on January 1, 2023, as a result of removing contingent income tax triggers. One adjustment in computing Iowa net income that would remain is Iowa Code 422.7(39A) (applicable for personal income tax purposes) and 422.35(19A) (applicable for corporate income tax purposes),2 which allows Iowa-specific adjustments when taxpayers have taken the additional first-year depreciation allowance in computing federal taxable income as allowed by IRC Section 168(k).
Current Iowa Code 422.7(60) (for personal income tax purposes) and Iowa Code 422.35(27) (for corporate income tax purposes) decouples the Iowa tax law from the IRC Section 163(j) limitations on the amount of interest that can be claimed as a business expense deduction. Under current law, however, the Iowa tax benefit of interest decoupling is only available for tax years in which Iowa does not allow businesses to use bonus depreciation. Sections 55 and 56 of SF 619 would unconditionally decouple Iowa tax law from the federal IRC Section 163(j) business interest expense limitation for individual and corporate taxpayers for tax years beginning on or after January 1, 2021.
Removal of contingent income tax "triggers"
2018 Iowa Acts, chapter 1161, Division IX enacted contingent income tax changes that depended upon the Iowa General Fund reaching certain revenue targets, or triggers, for Iowa's fiscal year ending June 30, 2022. If those conditions were met, the income tax changes would have become effective in 2023. SF 619 removed the necessity for the triggers to occur and specifies that the provisions in the law enacted in 2018 take effect January 1, 2023.
The following are some of the more significant provisions that will become effective in 2023.
Definition of Iowa net income for corporations
For corporate income tax purposes, current Iowa Code 422.35 defines "net income" as federal taxable income after the federal dividends-received deduction but before the federal deduction for net operating losses. Starting in 2023, Iowa Code 422.35 would be amended to define "net income"3 as taxable income properly computed for federal income tax purposes under IRC Section 63. Iowa is a separate-return-reporting state that allows taxpayers to elect to join in filing as a nexus-consolidated group. Taxpayers will need to prepare a proforma federal return as a separate taxpayer or a nexus-consolidated taxpayer, as the case may be, to determine the federal net operating loss available. Taxpayers will also need to consider other Iowa-federal disconnects, such as Iowa's exclusion of global intangible low-taxed income4 from Iowa taxable income, in computing their Iowa net operating losses.
Iowa Code 422.35(11) would further be amended to require any federal net operating loss deduction carried over from a tax year beginning before January 1, 2023 to be added back to net income. Any Iowa net operating loss carried over from a tax year beginning before January 1, 2023 may be deducted as under current law.
Definition of Iowa net income for corporations
SF 619's removal of the contingent income triggers under the 2018 law would automatically modify Iowa Code 422.35,5 which prescribes how net income is computed for Iowa corporate income tax purposes. Several statutory adjustments would be struck from Iowa Code 422.35 starting in 2023. Among the stricken adjustments would be the following:
Individual income tax rates
New Iowa Code 422.5A (which was enacted by the 2018 law and whose contingency removed by SF 619) would reduce the number of individual income tax rate brackets from nine to four. The applicable individual income tax rates, beginning in 2023, will be as follows:
Individual income tax exclusion for capital gains narrowed
Current Iowa law has complex rules governing the deductibility of certain capital gains. Starting in 2023, Iowa Code 422.7(21) would be amended to narrow this deduction to the net capital gain from the sale of real property used in a farming business if certain conditions are satisfied.
Paycheck Protection Program — fiscal-year taxpayers
Current Iowa law grants an income tax exemption and associated expense deduction for forgiven federal Paycheck Protection Plan (PPP) loans for tax years beginning on or after January 1, 2020. SF 619 would extend the same benefit to fiscal-year taxpayers who received PPP income in tax year 2019.
Inheritance tax phase-out
Iowa is one of a handful of states that imposes an inheritance tax. Under current law, an inheritance received by a lineal ascendant or descendant is exempt from the Iowa inheritance tax regardless of the value of the estate or the amount inherited. Tax rates from 5% to 15% may apply to inheritances that are not exempt. SF 619 would phase out the inheritance tax rate over five years by reducing the effective tax rate by 20 percentage points per year over four years and then eliminate the tax entirely on January 1, 2025 (for deaths occurring on or after that date).
Taxpayers will need to consider the immediate application of Iowa's adoption of federal bonus depreciation for qualifying asset purchases on or after January 1, 2021. Fiscal-year taxpayers that had PPP loans forgiven in 2019 and already filed Iowa returns may want to consider amending their returns due to the expansion of Iowa's exemption to 2019. Taxpayers will also need to consider the effects of the various changes to Iowa's income tax laws starting in 2023 that are no longer contingent on certain revenue thresholds being met.
1 See e.g., Iowa Code 422.7(39), (39A) and (39B) (for personal income tax purposes) and 422.35(19), (19A) and (19B) (for corporate income tax purposes).
2 Under Iowa Code 422.35(19A), the additional first-year depreciation allowance authorized in IRC Section 168(k) does not apply in computing net income for Iowa tax purposes. If the taxpayer has taken the additional first-year depreciation allowance for purposes of computing federal taxable income, then the following adjustments must be made: (a) add the total depreciation taken on all property for which the election under IRC Section 168(k) was made for the tax year; (b) subtract the depreciation allowed on that property for the tax year using the modified accelerated cost recovery system depreciation method applicable under IRC Section 168 without regard to IRC Section 168(k); and (c) make any other adjustments to gains or losses to reflect the adjustments made in subparagraphs (a) and (b) under rules adopted by the Iowa tax authorities. A nearly identical provision applies for personal income tax purposes and is codified at Iowa Code 422.7(39A).
3 The 2018 law made similar amendments to the definition of "net income" and the provisions for net operating loss carryforwards for personal income tax purposes in Iowa Code 422.7 and 422.9.
4 Iowa Code 422.35(28) enacted for tax years beginning on or after January 1, 2019.
5 Similar changes are also implemented, beginning in 2023, under Iowa Code 422.7, which prescribes Iowa's definition of "net income" for individuals and pass-through entities.