Other Notable Provisions
State and Local Tax Deduction (SALT)
The deduction for state and local income, sales, and property will be retained, but capped at $10,000. The cap is not adjusted to inflation. For the most part, there will be no immediate impact from the repeal of the state and local income tax deduction on state revenues. Most states require taxpayers to add back their state income tax deductions when calculating their itemized deductions for state purposes, which avoids the possibility of allowing a deduction for state income taxes in computing that same tax. A few states—Arizona, Georgia, Hawaii, Louisiana, North Dakota, Ohio—do allow or limit the federal amount of the SALT deduction, but North Dakota is the only one of these states that could see an increase in revenue from the SALT deduction cap, as it uses federal taxable income as its starting point.
The cap on the SALT deduction will raise the effective burden of state income taxes on higher income earners. This could result in a shift of a state’s tax levy mix in the long-term and cause them to move away from income taxation to lessen this burden. New Jersey could potentially delay plans to seek out higher marginal income tax rates in light of the changes to the SALT deduction.
States are pursuing potential workarounds, however, to either effectively preserve the SALT deduction in its entirety or to alleviate possible tax increases for individual taxpayers. For instance, the Tax Cuts and Jobs Act keeps the deduction for charitable contributions. According to the IRS, individuals can give charitable contributions to federal, state, and local governments. Thus, some state and local governments are exploring setting up public purpose funds and providing a credit that nearly or completely offsets state and local taxes. If these public purpose funds were found to meet IRS charitable giving guidelines, donations to these funds would be deductible at the federal level. Many tax experts, however, believe that such a workaround would not withstand a challenge in court.
Some states have also floated the idea of switching from an income tax, which is levied on employees, to a payroll tax, which is levied on employers and is considered a deductible business expense. Changing who is responsible for the tax could allow states to collect the same amount of tax revenue and could reduce the number of individual taxpayers that would be negatively effected from the $10,000 cap on state and local tax deductibility.
Affordable Care Act Health Insurance Mandate
The TCJA reduces the Affordable Care Act's (ACA) penalty for not obtaining health insurance to $0 beginning in 2019, which effectively repeals the mandate. (In 2018, the penalty for forgoing health insurance will be $695 per adult or 2.5% of household income, whichever is larger.) According to the Congressional Budget Office, repealing the individual mandate would reduce federal budget deficits by around $338 million by 2027. They estimated that the amount of individuals with health insurance would decrease by 4 million in 2019 and 13 million in 2027. CBO also projected that average premiums in the nongroup market would increase by around 10 percent in most years of the decade, not accounting for any changes in the ages of people purchasing insurance. This provision may potentially place an obligation on states to increase healthcare spending in future years.
The Tax Cuts and Jobs Act doubles the estate tax exclusion amount from $5.6 million to $11.2 million. Twelve states and the District of Columbia have an estate tax. For the ones that conform to the federal estate tax, doubling the threshold could mean less revenue. For the states that do not, this could create more of an incentive for taxpayers to locate to a state that does not levy one.
Contributions to Capital
The bill provides that the term “contributions to capital,” which are excluded from a corporation’s gross income, does not include contributions by government entities. This means that grants from state and local governments given to businesses as incentives will now be federally taxable.
Changes to Education Savings
Prior to federal tax reform enacted in 2017, families were only able to use 529 tax-free saving accounts for college expenses. According to The Pew Charitable Trusts 2017 report, “How Governments Support Higher Education Through the Tax Code,” all states that impose an income tax mostly conform to the federal exclusion of 529 plan earnings. Following federal tax reform, these accounts may now also be used for expenses at an "elementary and secondary public, private or religious school." Some states set a maximum deduction or credit for contributions to these plans while others do not set a cap for either. Because of the expansion of eligible expenses, some states may see growing costs, particularly those that do not set a cap on deductions or credits for plan contributions.
What Did Not Change?
- Private Activity Bonds: The final bill does not include a House provision to eliminate tax deductibility of private activity bonds, which are used by state and local governments to fund infrastructure projects.
- Most ACA Taxes: TCJA does not repeal many taxes that from the Affordable Care Act (ACA), such as the Medical Device Tax or the “Cadillac tax” on high-cost insurance plans. Republicans are trying to address these taxes in separate legislation.
- Retains the student loan deduction, the medical expense deduction and the graduate student tuition waivers.
- Retirement Accounts: Retirement accounts such as 401(k) plans stay the same.
States experienced some effects due to the mere possibility of reform, as taxpayers who have the ability to defer income have done so assuming that their taxes will be cut. There are even examples of states that took pre-emptive action in 2017. For example, Oklahoma decoupled from the Internal Revenue Code (IRC) by freezing its standard deduction. At the time, doubling the standard deduction was being considered in congressional tax reform talks and posed a potential loss of revenue for the state, which had been grappling with budget challenges.
Additionally, other states performed analyses of possible revenue changes as a result of federal tax reform. Some state analyses are listed below:
- Arizona's Joint Legislative Budget Committee published a revenue report looking at the fiscal impact of federal tax conformity. (January 22, 2018)
- Arkansas Department of Finance and Administration provided a broad overview on the Tax Cuts and Jobs Act. (February 5, 2018)
- California Franchise Tax Board released a preliminary report on specific provisions of the federal tax law. (March 30, 2018)
- Legislative Council Staff Economists authored a memo on the federal tax legislation that projects increases in income tax revenue beginning FY2018 through at least FY2027. (March 5, 2018)
- Legislative Council’s Economic and Budget Outlook projects an increase in state revenue from federal tax reform. (December 2017)
- Idaho's State Tax Commission released an analysis of the state impact of federal tax reform. (January 19, 2018)
- Illinois Department of Revenue posted an explanation of the impact on Illinois tax revenue resulting from federal tax reform. (March 1, 2018)
- Kansas Department of Revenue issued a note in January about federal tax cuts impacting December receipts. (January 2018)
- Maine Revenue Services' Office of Tax Policy prepared a report on the impacts of the Tax Cuts and Jobs Act on the state. (January 2018)
- Maryland's Bureau of Revenue Estimates published a report that examines the effects of federal tax reform on the state. (January 25, 2018)
- Michigan Governor Rick Snyder (R) released a statement regarding the revenue impact due to the Tax Cuts and Jobs Act. (January 8, 2017)
- The Minnesota Department of Revenue has released a preliminary estimate of the state budget impacts stemming from the passage of the Tax Cuts and Jobs Act. (January 9, 2018)
- Missouri House Appropriations Analysis: The impact of the standard deduction is a primary concern. It is estimated that the increased standard deduction will decrease Missouri revenues by $516.2 million. Since the value of itemized deductions will decline, more people will take the standard deduction, and the people who continue to itemize will realize a smaller deduction. Therefore, the combined effect will be a reduction in income tax collections of $120 million. (November 2017)
- Montana DOR estimated revenue changes of major provisions. (Part II) (December 5, 2017)
- New York:
- North Carolina detailed the impact of federal tax reform on state revenue in its General Fund Revenue Update. (January 2018)
- North Dakota’s Tax Commissioner's website on how federal tax reform will impact the state.
- Vermont's Economic Review and Revenue Forecast Update has an appendix (Appendix B) focused on potential state revenue impacts. (January 2018)
- Virginia Division of Legislative Services authored a legislative issue brief on federal tax reform's impact on the state. (January 2018)
- Washington's Economic and Revenue Forecast Council presented TCJA's impacts to the state's Senate Ways and Means Committee. (January 18, 2018)
- Wisconsin's Legislative Fiscal Bureau released a publication on the federal tax law changes enacted in 2017. (February 13, 2018)