State Revenue Departments, Employers Adjust To Midyear Changes for Income Tax Rates

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By Caitlin Reilly

Several states made significant changes to income tax this summer, in some cases in political showdowns that left revenue departments and employers scrambling to keep up.

Seven states passed legislation or announced changes to tax rates or brackets in June and July. However, three states in particular—Illinois, Kansas, and Maine—passed retroactive changes amid political turmoil that made it difficult to anticipate the outcome and plan ahead.

Illinois and Kansas legislatures passed retroactive tax rate increases with bipartisan measures that overrode governors' vetoes. In Maine, the highest tax bracket was eliminated after a divided legislature and the governor reached a compromise following a three-day government shutdown.

Accommodating Retroactive Adjustments

Retroactive changes may pose challenges to employers because in addition to incorporating new rates, employers may have to adjust past withholding.

States handle retroactive changes differently, so employers should monitor state revenue departments for guidance. Illinois and Kansas provide frameworks for how states may address changes with retroactive effective dates.

In Illinois, changes were straightforward, even if the passage of the legislation was not.

The flat income tax rate was increased to 4.95 percent from 3.75 percent by a bill approved July 6, with a retroactive effective date of July 1. New tables were issued the next week.

In Kansas, changes were more complicated. A new income tax bracket and higher tax rates for existing brackets were established under a measure approved June 6 in a vote that overrode a veto from Gov. Sam Brownback (R).

The new bracket and new rates were retroactively effective Jan. 1, 2017, leaving employers with six months of underwithholding. Additionally, the rates were scheduled to increase again Jan. 1, 2018.

New withholding tables were issued June 28 that used the 2018 tax rates, which were higher than the 2017 rates, to account for underwithholding. Using the 2018 rates also saved the department and employers from changing withholding again in six months.

In some cases, a state may release new tables at the new rate and handle any adjustments to tax liability through individuals' returns, or the state may issue tables with withholding rates higher than the new tax rate to account for underwithholding on the employer side.

In Maine, a tax bracket that took effect in Jan. 1, 2017, following approval of a ballot measure by voters, was eliminated retroactive to the day the bracket took effect. The July 4 measure reduced the tax rate for top earners to 7.15 percent from 10 percent, retroactive to Jan. 1.

The state revenue department is still working to update schedules and withholding tables. New tables tell employers how the revenue department plans to accommodate over withholding that occurred as a result of the law.

In Ohio, the two lowest tax brackets were eliminated and bracket thresholds were adjusted retroactive to Jan. 1 under a budget bill signed June 30 by Gov. John Kasich (R). However, table modifications were not necessarily guaranteed because the bracket changes were minimal, a Department of Taxation spokesman told Bloomberg BNA. If new tables are not released, any overwithholding would be reconciled through individual returns.

Another thing employers should watch out for when state legislatures make changes to tax rates is other changes related to, but not addressed in, the legislation. In Kansas, the supplemental withholding rate was increased to 5 percent from 4.5 percent, effective July 1, even though the law did not require it.

Changes on the Horizon

Other states that made changes to income tax this summer left employers with more lead time to prepare. Hawaii and Missouri scheduled changes to income tax rates and brackets that are to take effect Jan. 1, 2018. North Carolina scheduled a rate change for tax year 2019.

For tax year 2018, top earners are to be taxed at new rates in Hawaii. The state added three brackets, which are to increase taxes for those earning more than $150,000.

In Missouri, the tax rate for the highest tax bracket is to decrease 0.1 percent for tax year 2018 because a revenue threshold set up by a 2014 law was met. The top bracket's rate is to decrease by that amount each year the threshold is met, until the highest bracket is eliminated.

In North Carolina, legislators overrode Gov. Roy Cooper's (D) veto, to decrease the flat income tax rate to 5.25 percent from 5.499 percent in 2019. The decrease fits into a trend for North Carolina, which lowered its tax rate in 2017. In North Carolina, the withholding rate is 0.1 percent higher than the tax rate, so the tax year 2019 withholding rate would be 5.35 percent.

To contact the reporter on this story: Caitlin Reillyin Washington. To contact the editor responsible for this story: Michael Baer at mbaer@bna.com.

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