Filing your 2018 taxes has really been a unique experience this year. Headlines have well documented smaller or larger federal tax and a surprise balance due. What’s been lost, however, is the downstream impact of federal tax reform on your state tax liabilities. The majority of states base at least some part of their state income tax law on the federal tax code, meaning that the changes at the highest level of our government ripple across the states as well. Let’s dig in with how different states were impacted and how they responded to federal reform.
When it comes to income tax, states typically fall into one of three categories: no tax states, states whose income tax is calculated independently from federal income tax, and states whose income tax calculations at least partially align with the federal income tax. We’ll discuss each.
1. States Without Income Tax
- Pennsylvania, Nevada, Tennessee, Texas, Alaska, New Hampshire, South Dakota, Washington and Wyoming
As you could probably guess, states that don't have income taxes didn't have their tax codes sharply impacted by tax reform. However, the elimination of the State and Local Tax Deduction included repealing the deduction for sales tax, had a noticeable impact since states without income tax typically generate a meaningful portion of their revenue from sales and property taxes. So while the state's actual tax code may not have shifted, residents are not getting the benefit of that SALT deduction any longer, meaning more money paid out in income tax overall than they may have experienced in years past.
2. States That Self Calculate
- Pennsylvania, New Jersey, Arkansas and Mississippi
These states fall in the same category as the states without income tax when it comes to the SALT deduction elimination and a lower impact than the states who rely on federal tax code for their own income tax laws. However, it’s not as cut and dry as you may think. For example, Pennsylvania doesn’t conform to U.S. federal law on any front, but it does use the same small business expensing rules. In many cases, even for these self-calculating states, there is a ripple effect that flows down from federal changes.
3. States that Conform to Federal Law
The last category is the most complicated. Many states conform at least partially to federal law and this group can be further divided into two categories:
a) Rolling Conformity:
States whose statutes conform automatically to federal law. For example, if a state adopts the “federal standard deduction” then the value of the state standard deductions changes when the federal standard deduction changes.
The Impact of Tax Reform in Rolling Conformity States
Includes: Michigan, New York, Massachusetts, Montana, North Dakota, Rhode Island, Illinois, Connecticut, Colorado, Nebraska, Missouri, Maryland, Delaware, Washington D.C., Utah, Kansas, North Carolina, New Mexico, Oklahoma, Louisiana, Alabama
If you live in a state that has rolling conformity, or automatically conforms to federal changes, it’s likely that things are a bit more complicated than for states who don’t rely on federal law for their state tax codes. The impact of tax reform depends on what things conformed to Federal law and which aspects of the state income tax are different from Federal. For example, some states define their own standard deduction. That means any resident of state who has their own state standard deduction is not getting the benefit of the bigger federal standard deduction. At the same time they lose the benefit of many deductions like the previously discussed SALT deduction.
For example, if you’re a resident of New York, not only you’re losing your benefit for paying one of the highest state income taxes in the country, you’re also not getting the $24,000 per married couple standard deduction the federal government is handing out. The net effect is that you’ll likely be paying more in state income taxes this year than you did before tax reform. As you’ll see in a minute, this is an issue for residents of many other states as well.
b) Static Conformity:
States that align to federal law as of a specific date (for example "federal standard deduction as of 1/1/15") and require legislative action to re-align with the new federal statute. In some cases, states did pass legislation to update their tax codes but there are many who have not.
States with Static Conformity
- Iowa, Wisconsin, Indiana, Minnesota, Ohio, Vermont, Maine, Idaho, Oregon, California, Arizona, Kentucky, West Virginia, Virginia, South Carolina and Georgia
States with Static Conformity and No Legislative Action
For states that have to pass new legislation to conform to the federal tax code, there was limited time to make adjustments for 2018. Many states were unable to pass new tax laws to sync with federal reforms before the end of the 2018 tax year, which created issues for residents who had to file their taxes under two different tax systems. One of the biggest issues for filers is that some people were left filing for the standard deduction on their federal filing while still needing to itemize their deductions for their state filing.
Minnesota was one such state. In order to take some of the pressure off of their residents, the Minnesota Department of Revenue was proactive and created a new form, M1NC, to help navigate the differences between tax systems.
States That Require New Legislation to Conform and Have
The other option for states who needed to pass a law to get in line with the federal tax laws was to do just that. The states listed above have done that, and some have gone above and beyond to enact their own tax code overhaul, like Iowa.
Understanding Your State Income Tax
If you thought federal tax reform was confusing, the complexity doubles down when you consider the impact of your state, or states, where you file. It’s been a difficult time for accountants all over the country trying to navigate these new rules, especially for those of us with clients who file multiple state tax returns. As frustrating as this process may be, remember that you’re not alone and instead of being frustrated with your CPA, give them a hug this tax filing season. They are earning their keep.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Brian Vnak has been helping clients create intricate financial, tax and estate strategies that are in line with their goals and values for more than 10 years. His popular column for Kiplinger.com is published monthly.