The federal definitions of income affect income tax states in a way that will force them to change.
The real takeaway here is that income tax states face a disadvantage compared to states that have no personal income tax. The income tax states virtually all base their code on definitions that were once included in the federal tax code. Now that the federal tax code has changed, the states must also change or, in many cases, residents will have to pay a lot more.
I would love for income tax states to consider getting revenue by some means other than personal income.
CNBC reports, “Federal Tax Cuts Leave States in a Bind.”
Apart from the nine states with no broad-based income tax, nearly every state will face a similar decision. Almost all of the states base their tax codes in some way on federal definitions of income, before applying their own adjustments and deductions and setting their own tax rates.
The federal tax overhaul, which eliminated or capped several deductions and exemptions, effectively broadened what counts as income for some families. Previously, for example, a married couple with three children earning $70,000 might have been taxed on only about $36,000 of that income, according to the Tax Policy Center, a research group. The tax law, however, eliminated the so-called personal exemption and made other changes, which could increase this family’s taxable income to about $46,000.
At the federal level, those changes were more than offset for most families by lower tax rates and an increased child tax credit. In the example of a married couple with three children, the family’s federal tax bill would be lowered by more than $2,000 under the law. At the state level, however, the changes leave families owing tax on a larger share of their income, without the reduced rates or new credits to soften the blow.
A handful of states have already taken action, in some cases using the extra revenue from the federal law as lubrication for deal-making. Colorado, for example, took advantage of its estimated $200 million in extra revenue to pass a budget that included extra funding for roads, public education and school security. Idaho, on the other hand, moved quickly to return the revenue windfall to residents through tax cuts.
The challenge is especially acute in Minnesota because its tax code is closely tied to the federal definitions.
The Minnesota Department of Revenue estimates that if the state tax code incorporates the federal change in calculating taxable income, 870,000 Minnesota families will pay more for the 2018 tax year, by an average of $489 per person.
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