March 2, 2022
Iowa governor signs legislation that changes corporate and individual income tax rates and overhauls the research activities credit
On March 1, 2022, Iowa Governor Kim Reynolds signed House File 2317 (HF 2317), which enacts contingent rate reductions for the state's corporate income tax and phased-in rate reductions for its individual income tax. HF 2317 also makes significant changes to the state's research activities credit.
Contingent rate reductions for Iowa's corporate income tax
For tax years 2021 and 2022, the Iowa corporate income tax is based on the following graduated rate schedule:
HF 2317 amends Iowa Code Section 422.33 to reduce the corporate income tax beginning in 2023 if certain revenue triggers are satisfied. The new provision (Iowa Code Section 422.33(1)(b)) requires both the Iowa Department of Revenue and the Iowa Department of Management to determine by November 1, 2022 (and by November 1st of each year thereafter) whether net corporate income tax receipts in the prior fiscal year exceeded $700 million. If they did, then the 9% and 9.8% rate brackets would be adjusted to generate $700 million in net corporate income tax receipts. Those rates will apply to tax years beginning on or after the next January 1st following the determination date. In no event, however, can the rates decrease below 5.5%.
Overhaul of research activities credit
Under current law, Iowa allows a refundable research activities credit for 6.5%1 of Iowa's apportioned share of qualifying expenditures for increasing research activities. The Iowa research activities tax credit is generally based on the federal research tax credit, except that the Iowa credit is calculated using the ratio of Iowa research expenditures over total research expenditures.
HF 2317 significantly changes the research activities credit. The law limits the amount of credit in excess of the tax liability that can be refunded. The refundable portion of the credit will be phased down 10% each year for a five-year period starting in 2023, so that 90% of excess credit is refundable in 2023 and 50% of excess credit is refundable in 2027. A taxpayer claiming a refund can elect to have the overpayment otherwise eligible for a refundcredited to the following tax year's liability. HF 2317 includes no provision allowing taxpayers to carry forward the unused portion of their refundable credits.
For tax years beginning on or after January 1, 2023, taxpayers are required to compute the research activities credit in a manner consistent with the alternative simplified credit in IRC Section 41(c)(4) if they elected, or were required to use, this method for federal income tax purposes for the same tax year. Prior to this change, taxpayers could make an election to alternatively compute the credit in a manner consistent with the alternative simplified credit in IRC Section 41(c)(4), regardless of the method they used for federal income tax purposes.
The eligibility of payments for supplies to be qualified Iowa research expenses is phased out over five years, starting in 2023. Thus, for tax years beginning on or after January 1, 2027, payments for supplies will not be qualified Iowa research expenses. HF 2317 also appears to limit the eligibility of wages performed by an employee or third parties. Wages are eligible for the credit if the person’s services are performed in Iowa and a majority of the total services performed by the person in the tax year directly relate to eligible projects. In addition, HB 2317 limits a taxpayer's ability to claim the credit on an amended return and adds new provisions for calculating the state's apportioned share of qualifying expenditures for increasing research activities (certain rules that apply in calculating the federal credit will not apply for Iowa purposes).
Finally, a taxpayer can only file an amended return increasing the credit that was claimed on a timely filed return if the amended return is filed within six months of the due date, including extensions, of the original return or if the increase resulted from an assessment under a federal or Iowa Department of Revenue examination.
Other tax credits
HF 2317 limits the amount of the redevelopment tax credit, the third-party developer tax credit, the historic preservation tax credit and the assistive device tax credit that can be refunded. The amount of the refundable credit will be reduced by 5% each year for five-years, so that in 2023 a taxpayer will be allowed 95% of the refundable credit and by 2027 the taxpayer will only be allowed 75% of the refundable credit.
Rate reductions for individual income tax and treatment of retirement income
HF 2317 phases down individual income tax rates over the next four years to a flat rate of 3.9% by tax year 2026.
Under current law, Iowa does not tax Social Security income or retirement income of $6,000 or less. For tax years beginning in 2023, HF 2317 excludes from income tax the retirement income of someone who is (1) disabled, (2) at least 55 years old, or (3) the surviving spouse of an individual who would have qualified for the exclusion. Retirement income is defined as the total amount received from all governmental or other pension or retirement plans, including defined benefit or contribution plans, annuities, individual retirement accounts, plans maintained or contributed to by an employer or by a self-employed person as an employer, and deferred compensation plans.
HF 2317 also grants an employee-owner of a qualified corporation one irrevocable lifetime election to exclude from state individual income tax the net capital gain from the sale of the qualified corporation's capital stock. This exclusion will phase in over three years, beginning in 2023.
Retired farmers also will receive a similar capital gain exclusion as well as a lease income exclusion.
The contingent corporate income tax rate reductions, while certainly welcome, nonetheless create some uncertainty and unpredictability for Iowa corporate income tax planning for future years. The changes to Iowa's research activities credit are significant, with the phase-out of eligibility for purchases of supplies making Iowa an outlier among the states. Individual taxpayers who are employee-owners of a corporation contemplating a sale of that corporation should consider the phased-in capital gain exclusion before entering into any transactions.
EY will continue to monitor developments in this area.
1 One proposal would have reduced the credit rate to 4%, but it was not incorporated into the final version of HF 2317 that passed the legislature.