Iowa enacts significant income and sale and use tax changes

On May 30, 2018, Iowa Governor Kim Reynolds signed Senate File 2417, the state’s tax reform package and response to federal tax reform. The legislation provides a number of significant changes to the state’s corporate and individual income taxes, as well as to the sales and use tax code.

For both corporate and individual income tax purposes, except for certain carve outs, the state will begin to transition to rolling conformity. For the 2019 tax year, the state will conform to the Internal Revenue Code (IRC) in effect on March 24, 2018. For tax years beginning Jan. 1, 2020, Iowa will adopt rolling conformity with the IRC. Iowa is the first state to change the method of conformity since the enactment of the Tax Cuts and Jobs Act (Pub. L. No. 115-97, commonly known as the “TCJA” and enacted on Dec. 22, 2017).

A highlighted selection of Iowa’s tax reform changes are as follows:

Corporate income tax

The new corporate income tax provisions include:

Tax year 2017 changes:

• Contractors excluded from eligibility for the Iowa Research Activities Credit

Tax year 2018 changes:

• Limits who can earn the Iowa Research Activities Credit to those in the businesses of manufacturing, life sciences, software engineering, and or aviation/aerospace. Additionally, the credit is awarded only if the business claims and is awarded the federal credit. The credit is calculated on the same expenses as allowed in computing the federal credit

Tax year 2019 changes:

• Conforms to the IRC in effect on March 24, 2018, including the provisions of the TCJA, except as specifically phased in or excluded  (i.e.  no bonus depreciation)

• Federal section 179 deduction is limited to $100,000, purchase limitation begins at $400,000

• Changes to Iowa tax credit regime as follows:

  • New caps on the amounts of credits awarded annually
  • Authorization for a state tax credit study to determine the effectiveness of the various credits as a tool for economic growth
  • Repeal of the geothermal credit effective Jan. 1, 2019

Tax year 2020 changes:

• Full conformity to federal section 179 deductions and limitations

Tax year 2021 changes:

• A rate reduction for each corporate income tax bracket for years beginning on or after Jan. 1, 2021, reducing the top rate from 12 percent to 9.8 percent
• The alternative minimum tax (AMT) will be eliminated for tax years beginning on or after Jan. 1, 2021
• Federal deductibility will also be eliminated for tax years beginning on or after Jan. 1, 2021

Individual income tax

Senate File 2417 reduces the number of individual tax brackets from nine to four, lowering the top individual rate from 8.98 percent to a top rate of 6.5 percent, by 2023. However, these changes are contingent upon the state achieving certain revenue triggers. Until those triggers are met, the number of brackets remain the same, with minor reductions in the tax rates. Additional provisions include:

Tax year 2018 changes:

• Federal section 179 deduction is limited to $70,000, purchase limitation begins at $280,000. Allows owners to utilize qualifying section 179 expense received from pass-through entities that may be in excess of the individual cap
• Expands the benefits of 529 and ABLE plans
• Couples with the federal 2015 PATH Act, allowing teachers to claim an “above the line” deduction for qualified education expenses

Tax year 2019 changes:

• Couples with the IRC in effect on March 24, 2018, including the provisions of the TCJA, except as specifically phased in or excluded (i.e., no bonus depreciation and no state tax cap for computing itemized deduction)
• Federal section 179 deduction is limited $100,000, purchase limitation begins at $400,000
• Makes changes to the computation of the Iowa S corporation credit
• Allows like-kind exchange treatment under the IRC in effect on Dec. 21, 2017 for tax years beginning during the 2019 calendar year only
• Provides a Qualified Business Income (QBI) deduction (section 199A) at 25 percent of federal QBI
• Farmers are allowed a five-year net operating loss carryback

Tax year 2020 changes:

• Full conformity to federal section 179
• Provides a QBI deduction (section 199A) at 25 percent of federal QBI
• Couples with federal repeal of like-kind exchanges for all but real property

Tax year 2021 changes:

• Provides a QBI deduction (section 199A) at 50 percent of federal QBI

Tax year 2022 changes:

• Provides a QBI deduction (section 199A) at 75 percent of federal QBI

Tax year 2023 changes, provided triggers are met:

• Number of brackets reduced to four, rates reductions, with highest rate reduced to 6.5 percent
• Federal deductibility will be eliminated
• The individual AMT will be eliminated
• Changes the starting point for computing net income from federally adjusted gross income to federal taxable income, with certain modifications
• Provides a QBI deduction (section 199A) at 100 percent of federal QBI. (If triggers are not met, then deduction limited to 75 percent of federal QBI)
• Elimination of the Capital Gain Deduction, except for qualified sales of farm land to a qualifying relative

Note: if triggers are not met, none of the 2023 tax year provisions will be implemented. If triggers met in a subsequent year then the above provisions would be implemented starting with that year.

Sales and use tax

Economic sales tax nexus

Senate File 2417 enacts a number of sales tax expansion provisions. First, the bill enacts an economic sales and use tax nexus provision requiring remote sellers with no physical presence in Iowa to collect, remit and comply with all applicable provisions of the state sales tax code when remote sales are made to Iowa customers.

Accordingly, if a remote seller that does not have a physical presence with Iowa meets either of the following criteria in the current or previous calendar year, the remote seller is considered a “marketplace seller” and must collect and remit the sales tax and follow all applicable procedures as if the remote seller had a physical presence in Iowa: 1) gross revenue from Iowa sales equal to or exceeding one hundred thousand dollars, or 2) sales in two hundred or more separate transactions.

The requirements are substantially similar to the economic sales tax thresholds enacted in South Dakota, the constitutionality of which is currently under U.S. Supreme Court review in South Dakota v. Wayfair. The outcome of that litigation could overrule Iowa’s new economic sales tax nexus law. For more information on the status of Wayfair, please read our alerts  South Dakota v. Wayfair: What to know and how to prepare  and U.S. Supreme Court hears argument on Quill challenge.

Other remote seller provisions

• Use tax reporting: The bill also authorizes the Iowa Department of Revenue to adopt Colorado-style sales and use tax reporting provisions, including various reporting requirements and penalties for noncompliance.
• Cookie nexus: Marketplace sellers also include retailers that own, license or use “software or data files” that are installed or stored on property in the state. “Software or data files” include affirmatively downloaded software by a user, preloaded software, or web cookies.
• Marketplace facilitators: Marketplace facilitators, those that own, operate, or control a digital distribution service, digital distribution platform, online portal, or application store, must collect sales and use tax on the entire sales price or purchase price of sales facilitated by the marketplace facilitator.

A number of provisions were enacted pursuant, and in addition, to these remote seller provisions. Economic sales and use tax nexus, and the other nexus expansion provisions, are generally effective Jan. 1, 2019.

Miscellaneous sales tax provisions

The bill expands the sales tax base by imposing the tax on “specified digital products” and services. “Specified digital products” include electronically transferred digital audio-visual works, digital audio works (including ringtones), digital books, software-as-a-service, or other digital products, including greeting cards, images, video or electronic games or entertainment, news or information products, and computer software applications. An exemption is provided for businesses using digitals goods within a commercial enterprise, professional service, or an occupation (farmers). Non-profits are excluded from the exemption.

The tax was also applied to a number of services, effective Jan. 1, 2019 unless otherwise specified, including:

• Subscription services, effective on enactment
• Ride share services
• Online travel services
• Information services
• Photography and retouching services, effective July 1, 2018
• Video game services and tournaments
• Services arising from or related to installing, maintaining, servicing, repairing, operating, upgrading, or enhancing specified digital products

Finally, the bill amends the definition of “manufacturer” to specifically exclude those who are not “commonly understood as manufacturers,” such as construction contracting, repairing tangible personal property or real property, providing health care, farming, and transportation for hire. Additionally, “manufacturing” excludes activities occurring on premises primarily used to make retail sales. Essentially, this provisions disqualifies most retailers from the manufacturing exemption. The amended manufacturing definition is effective upon enactment of the bill.

Takeaways

Senate File 2417 represents months of discussion and debate, resulting in a historic tax reform package for the state of Iowa. Due to the number of new income tax and sales and use tax provisions, amendments, and technical changes, taxpayers should carefully review the bill and understand that further legislation and regulatory action pursuant to the tax reform package is probable. Additionally, understanding Iowa’s response to the TCJA is just as critical as understanding the myriad of new federal tax provisions.

For more information on state conformity, please read our blog, Federal tax reform and the states: Conformity is key. For more information on federal and state tax reform, please see RSM’s Tax Reform Resource Center.