It’s an election year, and the media has highlighted the federal tax reform solutions offered up by party nominees Donald Trump and Hillary Clinton. However, House Republicans have also outlined their own separate plan for federal tax reform, and it includes significant changes to the individual income tax system. Suggested changes include:
Consolidation of income tax brackets to three tiers (12%, 25% and 33%);
Elimination of the alternative minimum tax;
Taxation of capital gains, dividends and interest as ordinary income, but with a 50% exclusion;
Elimination of all itemized deductions;
Increase in the standard deduction.
These suggested changes would obviously have a significant impact at the federal level, but what would be the impact on the states?
Any changes to the federal tax code would likely have a trickle-down effect on state taxes. Many states conform to the Internal Revenue Code (I.R.C.) on a rolling basis, which means that any federal changes would immediately become the state’s new reference point for their state tax code. These states would then have to quickly decide whether they still want to follow the I.R.C., and whether they want to make any new modifications to the calculation of state income or decouple from certain federal provisions.
Some states have a static conformity with the I.R.C., which means that they follow the I.R.C. as of a specific date (ex. Jan. 1, 2016). An overhaul of the federal tax code would not have an immediate effect on these states, as they will need to pass legislation in order to conform to the I.R.C. as of its revision date.
All states (especially those that conform with the I.R.C. on a rolling basis) would face a huge administrative and legislative challenge if there were to be a “scrap it and re-write” approach to federal tax reform, as suggested by the House Republican plan. No matter what their provision for I.R.C. conformity, much of the states’ tax codes are made up of references to I.R.C. code sections. If the numbering and content of those I.R.C. sections change, then all the state’s references would need to change as well.
*Continue the discussion on Bloomberg BNA's State Tax Group on LinkedIn: How else might states be impacted by federal tax reform?
For more information, check out Bloomberg BNA’s Individual Income Tax Navigator by signing up for a free trial of the Bloomberg BNA Premier State Tax Library today.
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