In 2018, Iowa’s Governor signed sweeping changes to the state’s tax code into law. In general, Iowa’s new tax law aims to lower personal income tax rates, while aligning the state tax law with the new federal tax law. Here are a few of the most important changes that will affect most Iowans:
Here is how the local news covered the landmark legislation:
So what changed?
One change to Iowa’s tax law that will affect every resident, a change in Iowa’s income tax brackets for 2019.
The new Iowa tax law did not affect personal income tax rates for 2018. Under the old tax law, Iowa’s 2018 income tax brackets will remain as follows:
However, things will be different for 2019, through at least 2022.
Under Iowa’s new tax law, beginning in 2019 these rates will be reduced slightly:
The rates in the chart above will be your Iowa income tax rates through 2022 (although the exact income amounts will change slightly each year due to inflation). As Iowans, we can be happy to see a slight reduction in tax rates, but we will still be one of the highest taxed states in the nation:
Image from the Tax Foundation article here
There are not a lot of changes for Iowa’s 2020 rates except for a slight adjustment due to inflation:
The state standard deductions in 2020 for Iowans are also set to rise slightly:
For now, it also appears that the standard pension deduction for those over 55 years of age will remain at $6,000.
But the new tax law adds a twist. IF the State of Iowa hits certain revenue goals during the period between 2019 and 2022, the State’s personal income tax rates will be reduced even further starting in 2023, and Iowa’s personal income tax brackets will be simplified to only 4 brackets:
The slight reduction in Iowa personal tax rates starting in 2019 is signed into law. However, the changes are relatively minor. Even after the small reduction in personal tax rates, Iowans will still be one of the highest taxed in the nation.
This has a couple of impacts for those Iowans saving for retirement:
For those that have investments and savings in any taxable accounts, you need to invest your money wisely, or a large portion of your income may go to the state in the form of taxes!
How is the savings and retirement picture different for retiree in Iowa compared to a retiree in another state, for example Florida?
Let’s assume you are in the 22% federal tax bracket (A single person with income over $38,700 or a married couple with income over $77,400) and have a taxable savings account invested in a corporate bond that yields 3%, producing $30,000 in gross income (before taxes).
The Florida retiree will pay 22% federal income tax ($6,600) and be left with a net of $23,400 after tax (there is no state income tax in Florida).
A retiree in Iowa will pay an additional 8.98% in state income taxes ($2,694), leaving them with just $20,706 after state and federal taxes.
Paying that extra 8.98% in taxes hurts!
But there may be a way around it involving an investment that is very beneficial for Iowans – municipal bonds. If an investor in Iowa purchases qualified municipal bonds, the income from the bond will not be subject to state taxes.
Let’s say our Iowa retiree purchased an Iowa municipal bond instead of a corporate bond. For example, this municipal bond for the City of Cedar Rapids:
Note: This bond is used as an example only. This is not a recommendation to buy or sell any security.
The bond has a yield of 2.84%, which is under the 3% that this investor could get on a corporate bond. However, that does not mean that it is a worse, or even lower returning, investment!
Now, because of the lower 2.84% yield (compared to the 3% yield on the corporate bond), our Iowa retiree earns just $28,400 in income instead of $30,000. But, the income is not subject to Iowa state tax of 8.98%!
That leaves our retiree with $22,152 (after federal taxes), nearly $1,500 more than if they had chosen to invest in corporate bonds!
Municipal bonds are not always the best fixed income investment option, but for those in a highly taxed state such as Iowa, they can be incredibly advantageous in certain circumstances.
Because of Iowa’s added state income tax, any additional investment income is subject to higher taxes. This means that reducing portfolio turnover, reducing dividends, and investing in funds that are unlikely to kick off large distributions is very important.
Whether you use stocks, bonds, mutual funds, or ETFs, choosing an investment that reduces annual taxes is extra important for Iowans.
Investing with taxes in mind is important no matter where you are, for those in high tax states such as Iowa, it is vital.
With the new tax law, Iowa’s Section 179 deductions are changing, and will eventually conform to federal tax standards. For small business owners, this means a potential for huge tax savings.
Section 179 deductions allow for large, immediate deductions to account for the depreciation of assets. This depreciation can end up offsetting large amounts of income for those businesses or individuals that make large purchases of qualified equipment or property.
The IRS allows section 179 deductions up to $1 million dollars per year with a phaseout if the asset is greater than $2.5 million. However, Iowa offers a maximum deduction of just $70,000, with a $280,000 phaseout. And because of Iowa’s high tax rates, this means Iowans have lost a lot of potential deductions from their state taxes.
To see what this means for a typical Iowa small business, consider a farmer who just purchased a tractor for $400,000.
On their federal returns, the farmer may be able to take a section 179 deduction, and take a full $400,000 deduction on their federal income tax return this year.
But on their Iowa state tax return, things will look very different. Because the tractor was over the phaseout limit of $280,000 set by the state, the tractor was not eligible for a section 179 deduction, and instead would slowly be depreciated over a number of years on the farmer’s state tax return.
This leads our farmer to have significantly higher taxable income on his Iowa state tax return compared to his federal return. And when Iowa is taxing individuals at nearly 9% (and corporations as high as 12%), this means a lot of extra taxes.
Thankfully, over the next couple of years, this is changing.
Beginning in 2019, Iowans can deduct up to $100,000 (up from $70,000 today) in a single year, and the asset value phaseout rises to $400,000 (up from $280,000).
For our farmer, this means an immediate $100,000 tax deduction for 2019 if he holds off purchasing his tractor until 2019.
Then, beginning in 2020, Iowa’s state tax rules on section 179 deductions will couple with the federal tax law’s limits, which are currently a maximum $1 million deduction with a phaseout of $2.5 million.
This means a full $400,000 deduction for our farmer if he holds off purchasing his tractor until 2020.
This has broad implications for just about every small business owner in the state.
Consider our farmer used in the example above. If he can hold off on the purchase of his new tractor until 2019, he will be able to deduct up to $100,000 on his state tax returns, likely saving him up to $9,800 in Iowa state income taxes in 2019!
If that same farmer waits until 2020, when Iowa will allow up to $1 million in section 179 deductions, he can deduct $400,000 off of his Iowa state tax bill, saving up to $39,200!
Note: There is a lot of fine print when it comes to section 179 deductions. Only certain assets may apply, your business’ profit may limit your available deduction, assets must be primarily used for business purposes, etc.
At Arnold and Mote Wealth Management, we help clients navigate these changes and advise them on what purchases and capital allocations make sense today, and what is in their best interest to wait. Need help determining the best way to reinvest in your growing small business and take advantage of these new Iowa tax law changes? Or want to see how you can benefit from the tax law changes? We’re here to help.
Those are the “Big Two” changes that affect a majority of people in the state of Iowa.
Additionally, there are a few small changes that will have a slight impact on your Iowa taxes in the future:
If you wanted an excuse to cut your spending and save extra, this tax bill should provide you some incentive.
Under the new law, an additional 6% sales tax will now be levied on items such as your Netflix subscription, UBER and taxi rides, Amazon marketplace purchases and more. Obviously, the more you spend the more this change will affect you, but on average, it is expected to cost Iowa families an additional $50 per year.
With the new tax law, teachers are allowed a deduction of up to $250 for items purchased for their classrooms. This amount is coupled to the federal law teacher deduction limits, and will likely be slowly increased to offset inflation.
The reduction in the corporate tax rate for Iowa companies does not go into effect until 2021. For Iowa corporations, the top tax rate will be decreased from 12% to 9.8%, saving a company with $1 million in profit about $22,000 per year.
Even after the reduction, Iowa corporations will remain one of the highest taxed in the nation, with only Pennsylvania higher (at 9.99%).
How do these tax changes affect you or your business? Get in touch and let us help you find out!
The complete text of Iowa’s new tax bill is here: https://www.legis.iowa.gov/legislation/BillBook?ga=87&ba=sf2417