Illinois Raises Tax Rates - Will Iowa Benefit?

Illinois has announced that it will enact major increases to its tax rates.  Will Iowa benefit?  My friends at Radio Iowa have a story about this possibility.

The founder of sandwich company Jimmy John's, based in Champaign, Illinois, has already said he might move his company to Florida because of the rate hike.

Iowa's Dizzying Array of Tax Credits

In a recent post, I talked about 3 tax credits that are available to Iowans for various charitable contributions.  As a follow-up, I should note that these are just 3 of the approximately 30 tax credits that Iowa makes available to individuals and businesses for various things.  You may have noticed that the 3 credits mentioned in my last post can be confusing to decipher.  I can tell you that the other 27 (or so) credits are just as confusing. 

Iowa's dizzying array of obscure and confusing tax credits, coupled with multiple tiers of tax rates and a high "top rate," is why Iowa consistently ranks very low in terms of "tax friendliness." Plus, some of the credits have been very poorly administered and full of fraud.

College Savings Iowa Deduction Increases for 2011

The amount of deduction you can take for contributions to a "College Savings Iowa" program has increased by $54 for 2011.  The maximum deduction is now $2,865 per child, up from $2,811 in 2010.  The deduction limit is per parent, per child, so a married couple with two kids could deduct up to $11,460 in 2011 (4 x $2,865).

College Savings Iowa is Iowa's form of a "529 plan" that lets you save for college expenses.  Distributions from the plan are tax-free as long as the money is used for college expenses.  I wrote more about College Savings Iowa in this article.

Thanks to my friends at Radio Iowa for tipping me off to this story.

Special Iowa Charitable Credits

I spent quite a bit of time in December talking about charitable contributions and the deductions that taxpayers can take for those contributions.  Today, I'm going to talk about several tax credits that are available for certain charitable contributions made by Iowans. 

School Tuition Organization Tax Credit
Certain donations made to "School Tuition Organizations" may be eligible for a credit of up to 65% of the donation.  This credit is for contributions to qualifying private-school tuition organizations.  Chances are, you'll only consider taking this credit if your child attends a private school.  The school tuition organization will issue you a certificate, which must be attached to your tax return when you claim the credit.

Endow Iowa Credit
Donations made to certain community foundations in Iowa can be eligible for a tax credit of 25% of the donation.  The credit is non-refundable but any unused credit in the current year can be carried forward for up to 5 years.  This credit is administered by the Iowa Department of Economic Development and you have to file forms with them in order to claim it.  It is probably best to talk to a tax advisor before trying to claim this credit.

Charitable Conservation Contribution Credit
This credit definitely requires some planning and thought before it is claimed.  Iowans who donate land to a qualified organization for conservation purposes (such as donating land to a county conservation board) can claim a credit of up to 50% of the fair-market value of the land.  The maximum credit allowed is $100,000.  The credit is nonrefundable but any unused credit in the current year can be carried forward for up to 20 years.  It should be noted that the donation of land for conservation purposes is NOT always better than a sale of the land, in terms of net "cash in hand" after the transaction, even with the credit.  For this reason, it's important to talk to your tax advisor about your goals to make sure the transaction accomplishes what you want it to accomplish.

Tax Implications of the Unlicensed Daycare Provider

One of my areas of specialty is in-home daycare operations, and it's something I haven't blogged about much.  One of the questions about in-home daycare operations is what the tax consequences are to an unlicensed daycare provider.

Different states have different licensing requirements for daycare providers.  In Iowa, an in-home provider can care for up to 5 children without being registered or licensed.  A provider caring for 6 children must be registered, and a provider caring for 7 or more children must be licensed.  (Read more at the DHS website.)

For tax purposes, your in-home daycare is considered a business whether you or not you are registered or licensed.  Income should be reported as business income; legitimate business expenses can be claimed as a deduction against business income.

The tricky part for the unlicensed/unregistered is figuring out whether they can take the deduction for "business use of the home."  This deduction allows a taxpayer to partially deduct expenses associated with the house, such as utilities and mortgage interest.  Only daycare operators who are licensed or registered with the state -- or who are not required to be licensed or registered -- can take the deduction for business use of the home.

So in Iowa, a provider caring for less than 6 children CAN take the deduction for business use of their home, because they aren't required to be registered or licensed.  But if a provider cares for 6 or more children and is not registered or licensed, then no deduction is allowed for business use of their home.  Of course, aside from the tax deduction issue, there could also be problems with the DHS!

Federal Tax Provisions and the State of Iowa

One of the considerations of tax planning is the impact of state taxes.  Many states follow along with most federal provisions for calculating income, but almost every state varies from federal law on at least a few items.  This is often referred to as "de-coupling" from federal law. 

For example, Iowa in 2009 "de-coupled" from federal law on Section 179 expensing and bonus depreciation.  Section 179 expensing was limited to $133,000 (as opposed to $250,000 on federal returns), and bonus depreciation was not allowed at all on Iowa returns.  (Read more about this tax issue in this article.)

Iowa often "de-couples" from other "extender" items such as the front-side deduction for college expenses and the front-side deduction allowed to K-12 teachers for out-of-pocket classroom expenses.  These were a part of the federal tax bill signed into law last week.  The Iowa legislature will decide next month on whether to de-couple from these items and not allow them to be deductible on Iowa tax returns.  It is a safe bet that the legislature will vote to de-couple on these items, and also on the increase in Section 179 and bonus depreciation.

One federal provision that Iowa is coupling with is the provision in the "health care bill" passed earlier this year that allows people to keep children on their health insurance through age 26.  The value of this insurance coverage will be tax-free for federal purposes, and Iowa has announced that it will go along with federal law in this case.  Read more in this informational post from the Iowa Department of Revenue.

Section 179 and Bonus Depreciation for Iowans

Following up on my last post about Section 179 expensing and bonus depreciation:  one other aspect of tax planning for asset purchases is to examine what your state's rules are.  Some states, such as Iowa, do not follow federal guidelines for either Section 179 or bonus depreciation.

For example, in Iowa, Section 179 expensing is capped at $134,000, and bonus depreciation is not honored at all.  If your federal Section 179 expense exceeds $134,000, you'll only be able to deduct $134,000 as Section 179 expensing on your Iowa return; the rest will have to be depreciated.  This means an Iowan  could easily have to track two sets of basis and two sets of depreciation schedules - one for the IRS and one for Iowa.

Iowa isn't the only state that does this.  For example, I prepared an Ohio tax return last year, and they have a strange "5/6" rule on bonus depreciation and Section 179 expensing.  The rule gets its name because you have to add back 5/6 of the bonus depreciation amount as income on your Ohio tax return.  And for Section 179 expensing, you have to compare the amount of Section 179 expensing in the current year with the amount that would have been allowable if it was still 2002 (when the 179 limit was $25,000).  Basically, you add back to income 5/6 of the dollar amount of Section 179 expensing in excess of $25,000.

Preparing this Ohio return opened my eyes to the fact that Iowa, while it rightfully ranks very poorly in tax friendliness, is not the only state with mystifying tax rules.

Iowa Has a Bad Tax Climate

Iowa once again rates very poorly in the annual Tax Climate Index released by the Tax Foundation.  Iowa ranks 46th (5th-worst) in business tax climate, and 42nd (9th-worst) in individual income tax climate.

Iowa has the highest top corporate tax rate in the nation (at 12%) and a complex system of corporate taxation overall.  On the individual side, Iowa ranks low because of high rates and complexity.

This should come as no surprise to anyone who has dealt with filing an Iowa tax return.  You can read the full report here.

Homebuyer Tax Credits and Unmarried Couples

Unmarried couples in Iowa, and people who are considered unmarried by the federal government (i.e., same-sex couples married under Iowa law) may be able to take advantage of the homebuyer tax credits in ways that married couples cannot. As most of us know, there are two credits available, one for first-time homebuyers and one for long-time homeowners who buy a new house. First-time homebuyers can receive a credit of up to $8,000 for the purchase of a new home, while long-time homeowners can receive a credit of up to $6,500.*

A first-time homebuyer is defined as someone who has not owned a home in the three-year period that ends on the date the new home is purchased. A long-time homeowner is defined as someone who has owned and lived in the same home for at least five consecutive years out of the eight years ending on the date the new home is purchased.

The issue gets complicated when two people buy a home together, and one person qualifies for the first-time homebuyer credit and the other person qualifies for the long-time homeowner credit. For married couples, if one spouse qualifies for one credit and the other spouse qualifies for the other credit, then neither credit is available to the couple. However, this is not the case when the two people are unmarried – or are considered unmarried by the federal government.

Here’s an example, to help make this a little clearer:

Taxpayer A and Taxpayer B, husband and wife, buy a house together. “A” qualifies as a first-time homebuyer; “B” qualifies as a long-time homeowner. Because they are married, they are unable to claim either credit.

Now let’s say “A” and “B” are unmarried. Because “A” qualifies as a first-time homebuyer, the $8,000 credit is available. Additionally, “A” and “B” can split that credit any way they want. The only catch is, “B” cannot receive more than $6,500 (the maximum amount a long-time homeowner can get). So “A” could claim the entire $8,000, or “A” could claim $1,500 and “B” could claim $6,500, or any other reasonable allocation, as long as the total amount allocated doesn’t exceed $8,000 and “B” doesn’t receive more than $6,500.

What is not allowed is for “A” to claim $8,000 as a first-time homebuyer and “B” to claim $6,500 as a long-time homeowner on the same property. The credit is limited to $8,000 total for the property.

As you can see, this can be a complicated issue that is best worked through with the help of a qualified tax advisor. And remember, to qualify for the credit, the purchase contract on the home must be signed by April 30th, and you must close on the home by June 30th.

*-The credit is limited to the lesser of 10% of the purchase price of the home, or $8,000/$6,500.

This article does not constitute tax advice. Because each person’s tax situation is unique, it is recommended that you contact a qualified tax professional for further assistance.