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Tax Update Blog: Iowa Tax Law Archives

Iowa Department of Revenue shreds the Commerce Clause

March 08, 2012

If an Iowa Department of Revenue position on interstate income taxation stands, the limits set by Congress in 1959 on taxation of out-of-state corporations (PL 86-272) will become a dead letter. The Department is attempting to tax Jack Daniels -- whose only connection to Iowa is the sale of liquor to the Iowa state wholesale liquor monopoly -- based on the use of its trademarks in Iowa.

PL 86-272, enacted under the Constitutional authority given to Congress to regulate interstate commerce, prohibits states from taxing corporations whose only business in the state is the shipping of goods from out-of-state. The states are always trying to get around this, and Iowa gave itself a victory on this score when the Iowa Supreme Court ruled that KFC was taxable on royalties received from its Iowa franchisees even though KFC itself had no property, employees or operations in Iowa. Now the Department is turning this victory up to 11. From the Administrative Law Judge ruling in favor of the Department in an appeal by Jack Daniels Properties, Inc. and Southern Comfort Properties, Inc, members of the Brown-Forman group.

The department’s regulations are consistent with the supreme court’s interpretation of the statute. The regulations define “intangible property located or having a situs in this state” to include intangible property that “has become an integral part of some business activity occurring regularly in Iowa.” 701 IAC 52.1(1)(d), 52.1(4). The regulations expressly cite Geoffrey, which is the same case the department cited in the letters it sent to the protesters. The regulations go on to state that, if a corporation owns trademarks and trade names that are used in Iowa, a business situs for purpose of taxation may be present even though the corporation has no physical presence or other contact with Iowa.

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It is, of course, impossible for anybody who sells anything in Iowa other than generic products to avoid having "trademarks and trade names that are used in Iowa." As long as this position stands, it means that Iowa has weaseled its way around legislation designed to prevent this very result.

The Department of Revenue is entirely out of line here, but they will keep it up as long as they can get away with it -- and the KFC decision shows that Iowa's courts will let them get away with plenty. Congress is way overdue in restricting these overly aggressive positions by state revenue departments. Of course these overly-aggressive decisions are harder on smaller businesses, who have fewer resources to spend on tax compliance than Brown-Forman does.

It's also time for Iowa to form an independent tax court. The next time an administrative law judge opposes the Department on a significant issue may be the first time.

Finally, the Supreme Court should take another state tax case. The states have eroded the 1991 Quill decision to irrelevance with positions like this. It appears that the Supreme Court has to slap the states every couple of decades to keep them within the law.

Related: Iowa ruling: No Quill for you; or, Supreme Court silence trumps Supreme Court rulings

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Department of Revenue explains what Branstad didn't veto

July 29, 2011

The Iowa Department of Revenue explains in an e-mail to practitioners the provisions enacted this week when Governor Branstad signed most of SF 533:

Immediate Income Tax Changes for Iowa Taxpayers


Senate File 533 enacted on July 27, 2011 made changes impacting Iowa income tax provisions for tax years 2008, 2010, and 2011.


This legislation retroactively coupled with the following federal provisions for 2008:

• Tuition and Fees Deduction

• Educator Expenses Deduction

• Casualty Loss (10% limit; $100 floor)

Taxpayers who are impacted by these changes and have already filed returns for tax year 2008 may want to consider filing an amended Iowa tax return. Amended returns may be filed within three years of the original due date. No interest will be paid on refunds resulting from this legislation. NOTE: These changes are allowed only for the 2008 tax year. These changes are not allowed for the 2009 tax year since Iowa did not couple with tax changes affecting the 2009 tax year.

For 2010 and 2011 Individual Income Tax Filers Only:


• Taxpayers can make an adjustment on the 2011 tax year return for Iowa’s coupling with the federal Tuition & Fees Deduction and Educator Expenses Deduction for 2010. The taxpayer has the option to amend 2010 or adjust 2011.

For 2010 and 2011 Individual Income Tax Filers, as well as Corporate Income Tax (including S Corporations), Partnership, Fiduciary and Franchise Tax:

• Taxpayers can make an adjustment on the 2011 tax year return for Iowa’s coupling with the federal Section 179 expensing limit for 2010. The taxpayer has the option to amend 2010 or adjust 2011.

The Governor item-vetoed an increase in the Iowa Earned Income Tax Credit included in the bill.

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Governor Branstad item vetoes increase in Iowa earned income tax credit

July 28, 2011

Governor Branstad has vetoed the increase in the Iowa earned income tax credit enacted in the closing hours of Iowa's recently-ended legislative session. SF 533 would have increased the credit to 10% of the federal credit, from the current 7%. The refundable credit would have cost $28.5 million, according to the Governor. No other tax provisions were vetoed. From the veto message:

It is my desire to approach tax policy in a comprehensive and holistic manner. As such, I urge members of the House and Senate to continue to work with my office on an overall tax reduction package that both fits within our sound budgeting principles while reducing those taxes that are impeding our state's ability to compete for new business and jobs.

Comprehensive and holistic? I got your comprehensive and holistic right here.

Related: Legislature allows Iowans to take some 2010 deductions on 2011 returns

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Iowa House approves bill allowing 2010 expenses on 2011 returns; Senate future in doubt

June 09, 2011

The Iowa House of Representatives approved a proposal (HF 697) to allow Iowans to take advantage of 2010 tax breaks that weren't enacted until Apriil 2011 without amending returns. The proposal would give taxpayers the option of claiming their additional Sec. 179 expenses, educator expenses and higher-education deductions for 2010 on their 2011 Iowa returns. Otherwise the taxpayers could only claim the deductions by filing amended 2010 returns.

The proposal was passed as part of a broader budget bill, which puts its future in doubt. The Washington Examiner reports:

Democrats warned that Republicans were wasting their time on the House measure, saying the proposal will have no future in the Democratic Senate.

"This bill is dead as soon as it hits the Senate," said Rep. Bruce Hunter, D-Des Moines.

No progress has been made in bargaining between the House and Senate over a new state budget, though the fiscal year ends on June 30.

Related: Proposal would allow Iowans to claim some 2010 breaks on 2011 returns

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Proposal would allow Iowans to claim some 2010 breaks on 2011 returns

June 08, 2011

The Iowa legislature didn't get around to deciding what Iowa's 2010 income tax law was until April of this year. Thousands of Iowa returns were filed without claiming deductions enacted by the later-than-last-minute legislation (SF 512). Today the Iowa House is scheduled to debate a proposal to allow taxpayers the option of claiming those breaks on their 2011 returns in place of filing amended 2010 returns.

Amendment H-1735 to HF 677 -- the omnibus budget bill -- would allow taxpayers to take the following 2010 tax breaks on 2011 returns:

- The Section 179 deduction of up to $500,000 for otherwise depreciable equipment. The Iowa 2010 limit had been $134,000;

- The deduction for higher education expenses; and

- The $250 educator expense deduction.

This is a great idea. Amending an Iowa return to get a $250 educator deduction is hardly worth the bother of amending when you at best get a $22 refund. An S corporation claiming the increased Section 179 deduction may have multiple owners that have already filed 2010 returns; it may be a better deal to just hold the deduction over to 2011 than to pay to amend the 2010 Iowa return and all of the owner IA 1040s.

The bill also would allow taxpayers to amend their 2008 Iowa returns to claim the same teacher deductions, higher education expenses and the optional itemized sales tax deduction allowed on federal returns for that year. This is a strange provision, re-opening an old year for deductions that taxpayers have given up on. In fact, many taxpayers who accidentally claimed those deductions on Iowa returns for those years because they were on the federal return have paid assessments issued by the Department of Revenue for those items; they would then have to amend their returns to recover refunds for the deductions they claimed in the first place.

There apparently is no budget deal yet, so the passage of these provision can't be assumed. Still, it's good to see legislation that could save the expense of amending returns for small refund amounts.

Related: Iowa late changes: should you amend your returns?

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ISU Ag Law Center rounds up Iowa tax changes

April 25, 2011

All of the recent Iowa tax legislation, including Section 179 and bonus depreciation changes, is rounded up by the ISU Center for Agricultural Law and Taxation.

Related: The morning after the Iowa bonus depreciation veto

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The morning after the Iowa bonus depreciation veto

April 22, 2011

Now that the Governor has vetoed bonus depreciation for Iowa, what happens now?

From the Des Moines Register coverage, it sounds like the Democrats are truly unhappy with the veto message because it also blocks an increase in Iowa's Earned Income Tax Credit:

Rep. Tyler Olson, D-Cedar Rapids, accused Branstad of reckless action that unraveled a carefully crafted compromise. "His insistence on rewarding special interests and big corporations at the expense of small businesses and middle-class families is bad for Iowa and a serious blow to bipartisanship," Olson said.

The Republicans, in contrast, don't sound like they are all that upset:

Iowa House Speaker Kraig Paulsen, R-Hiawatha, said: "I'm pleased the governor signed the Taxpayers Trust Fund, giving Iowa taxpayers a seat at the table. Obviously, I'm disappointed that he chose to veto portions of the bill. House Republicans will continue to fight for tax relief for Iowans."

That doesn't sound like somebody ready to lead a veto override battle, and the Democrats won't be able to override the veto without help.

While tax conformity is always good, Iowa has been non-conforming with bonus depreciation for so long that one more year probably isn't that big of a deal. I do like this part of the veto message:

As earlier indicated, it is my desire to approach tax policy in a comprehensive and holistic manner. As such, I urge members of the House and Senate to continue to work with my office on an overall tax reduction package that both fits within our sound budgeting principles while reducing those taxes that are impeding our state’s ability to compete for new business and jobs.

If the Governor is really willing to deal with Iowa's real tax problem -- a ridiculously complex income tax with absurdly high rates undermined by dozens of special interest deductions and tax credits -- then maybe it's all worth it. Maybe - just maybe - the time is right for real tax reform in Iowa.

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Link: Radio Iowa Coverage

Prior Tax Update coverage:

Bonus depreciation for Iowa -- not so fast?
Conference Committee agrees to bonus depreciation for Iowa for 2011

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Bonus depreciation for Iowa -- not so fast?

April 21, 2011

Update, 4:15 pm: Governor item-vetoes 2011 Iowa bonus depreciation, enhanced earned-income credit. An insider tells me that since he let the "taxpayer relief fund" stand, there probably will not be an override. We'll see.


Nothing seems easy in Iowa tax policy this year. Now it looks like the Governor may veto the bonus depreciation provisions passed Tuesday by the legislature. The Des Moines Register reports:

Iowa Senate Majority Leader Michael Gronstal on Wednesday offered what he described as a compromise to break a stalemate over the state's budget, but it was quickly rejected by Gov. Terry Branstad.

The Republican governor also indicated he may veto portions of a tax relief and supplemental spending bill approved earlier this week by the Iowa Legislature. The situation could be an ominous sign as the House and Senate try to move towards adjournment of their annual session next week.

Governor Branstad appears mostly upset with the bill's setting a budget for only one year at a time. The Governor is trying to reinstate two-year budgeting in Iowa. But bonus depreciation may also be a problem:

"Other issues, involving the taxes, I think are better to be resolved in a bill that deals with taxes, not supplemental appropriations," Branstad said.

Stay tuned.

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Coupling bill passes Iowa Senate with $500,000 2010 Sec. 179 deduction

February 18, 2011

You might want to not file your Iowa business returns for 2010 quite yet.

The Iowa Senate yesterday passed its bill (SF 209) to update Iowa tax law for recent federal tax changes. The bill retroactively couples for 2010, and forward for 2011, for the $500,000 Sec. 179 deduction enacted last September. That is important for Iowa filers who are taking advantage of the increased Sec. 179 deduction on their 2010 returns; they may also be able to take it on their Iowa returns.

In contrast, the bill couples with the federal bonus depreciation rules only starting in January 2011.

The bill is not enacted yet, and Iowa's coupling deduction has been a mess for the past few years. As it hasn't passed, the 2010 Sec. 179 limit for Iowa officially is still $134,000. If you have to file now -- say, because you are a farmer trying to meet a March 1 deadline -- that's the number to use on your Iowa return. If you can wait, though, you might as well, to avoid having to amend your returns if the coupling legislation passes.

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Iowa to link to federal depreciation rules for 2011, Sec. 179 for 2010?

February 15, 2011

The Iowa Senate Ways and Means Committee yesterday approved this year's "code conformity" bill to link Iowa's income tax rules to the federal tax rules. The bill, SF 209,

The bill appears to adopt federal bonus depreciation and the $500,000 Sec. 179 limits. The bonus depreciation is effective for 2011, but not retroactively. The legislative language appears to make the Sec. 179 coupling retroactive to 2010. If the coupling is not retroactive, the Iowa Sec. 179 limit for 2010 is $134,000. The legislative explanation reads (my emphasis):

The division also decouples, for Iowa tax purposes, from the increased expensing allowance under section 179 of the Internal Revenue Code enacted by Congress as part of the American Recovery and Reinvestment Act of 2009 and makes a number of conforming changes. The changes take effect for tax years beginning on or after January 1, 2009, and before January 1, 2010.

I have emailed legislators for clarification and will post an update as soon as I hear back, as it means a lot for returns in process right now.

The bill couples retroactively for some minor breaks. For example, the bill would allow an Iowa deduction for sales taxes if that deduction is elected on the federal return. The bill also would conform Iowa the federal rules for excluding dependent health insurance.

The bill still has a way to go before it is enacted. If you have any Iowa items on your 2010 return that are on the 2009 list of federal-Iowa differences, you may want to sit on your Iowa return until conformity legislation is enacted; otherwise you may have to amend, or you may end up getting a payment notice from Iowa.

Other coverage: Sioux City Journal

Iowa Department of Revenue on 2010 conformity.

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The Governor returns to a familiar return

January 14, 2011

20111114-1Terry Branstad becomes Iowa's Governor again today after a 12-year break. If Rip Van Winkle, CPA had gone to sleep preparing a 1999 return after Tom Vilsack took office and woke with a fresh 2010 Iowa 1040 in front of him, he could get right to work. Even the rates are unchanged, except for inflation adjustments. The instructions on a few lines might trip him up, but he could get zip right along. Until he reached page 2.

On page 2 of the 1040 he would hit a reference to "Form 148" for tax credits. There he would stumble on the biggest change in Iowa's tax law since the last Branstad administration -- the proliferation of targeted tax credits. By my count, the 1999 1040 contained 13 credits of all kinds; the 2010 return shows 36. RVW, CPA would see, among others, a Wind Energy Production Credit, a Soy-Based Transformer Fluid Credit, an E85 Gasoline Promotion Credit, and two Film Tax Credits.

All of this might make him actually look at the instructions, where he would find other new complications that have crept into the Iowa tax law, including special computations in Iowa for taxable social security income. He would also find a whole bunch of items that where Iowa has strayed from the federal rules:

-Educator Expense deduction

-Tuition and Fee deduction

-Itemized Deduction for State Sales / Use Tax Paid

-50% bonus depreciation for property acquired after December 31, 2008 (and 100% -bonus as of 9/9/2010)

-Increased section 179 expensing of $250,000 for tax years beginning in 2009 and 500,000 for 2010 and 2011.

-Increase in the Iowa earned income tax credit for families with three or more children and married taxpayers

-Exclusion of the first $2,400 of unemployment compensation

-Deduction for the one-time registration fee related to the purchase of certain new vehicles

-Tax free treatment of IRA distributions donated to charity

20110114-2.jpgIn short, Governor Branstad returns to the same Iowa tax system he left behind 12 years ago, only even more complicated and loophole-ridden. He returns to an Iowa business tax climate rated the sixth-worst out of 50 states by the Tax Foundation -- bad enough that it will still be worse than Illinois even after this week's big honking tax increase.

Our new old Governor has his work cut out for him. He has urged cutting Iowa's highest-in-the-nation corporate tax rate in half, but other than coming out for a repeal of the scandal-ridden film tax credits, he has focused more on property tax issues than income tax issues.

What should he do? If he asked me for a to-do list, I would suggest, in order:

1. Kill the film credits dead dead dead.

2. Swear off and work to repeal economic development tax credits and targeted tax breaks.

3. Change Iowa's "code conformity" legislation so that federal changes would be automatically adopted in Iowa unless a law is passed to decouple. Now decoupling is the default.

4. Push a business-friendly, simple income tax system -- something like the Quick and Dirty Iowa Tax Reform.

Iowa's income tax needs a re-do badly. Nothing in Governor Branstad's history suggests he's likely to make radical changes. One his top aides is a veteran of Iowans for Tax Relief, a powerful group whose at-all-costs commitment to Iowa's deduction for federal taxes has done much to block tax reform. Unfortunately, if Rip goes back to sleep for another four years, he'll probably have no trouble recognizing Iowa's tax system when he stirs.

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Gronstal: forget coupling

March 11, 2010

It looks like Iowa isn't going to bother to couple with 2008 or 2009 changes in the federal tax law, reports the Quad City Times:

"It’s unlikely we’re going to find the ability to give up significant state revenue this year when we’re cutting every thing else in state government," Senate Majority Leader Mike Gronstal, D-Council Bluffs, said Wednesday.

Not conforming Iowa’s tax code to federal changes in 2008 or 2009 amounts to a roughly $90 million issue over the two years, said Jim McNulty of the state Department of Revenue.

That means taxpayers will have to make extra adjustments from their federal return to compute their Iowa taxable income. These will include:

- No bonus depreciation

- The 2009 Section 179 deduction for Iowa will be limited to $133,000. The federal limit for this deduction for the cost of equimpment that would otherwise be capitalized and depreciated is $250,000. Iowa has conformed to the 2008 Section 179 limit.

- No $250 deduction for educator expenses. This will trigger lots of $17 deficiency notices for teachers. (1040 line 23)

- No deduction for higher education tuition and fees (1040 line 34)

- No deduction for the sales tax paid for a new car purchase.

- No exclusion for the first $2,400 of jobless benefits.

- No Schedule A deduction for state and local sales taxes.

- No retroactive 2009 deduction for contributions to charity for Haiti disaster relief paid between 1/1/2010 and 2/28/2010.

One more argument for the Quick and Dirty Iowa Tax Reform.

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Iowa 2010 interest rates on overpayments, underpayments declines to 5%

October 23, 2009

Iowa has announced that the interest rate on late taxes or refunds will be 5% annually for 2010. The rate for 2009 is 8%.

Link: Historic Iowa interest rates.

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Iowans who used IRA distributions for charity get a surprise

August 26, 2009

The 150 ruling supergeniuses in the Iowa legislature failed to pass the usual "conformity" bill to link the Iowa income tax to the federal rules. This has caused a bunch of stupid little headaches. For example, the above-the-line teacher deduction didn't apply in computing Iowa taxes for 2008.

It didn't help that the Iowa Department of Revenue first told taxpayers to assume that a conformity bill would pass, before changing its tune later in tax season. Now the Department presents another annoyance: older folks who used the special rule make IRA distributions directly to charity face a stupid adustment to their 2008 returns.

When you have the IRA make the contribution, it bypasses your return entirely. The advantage of this is for most folks is that you don't raise your AGI, avoiding AGI-based phaseouts of personal exemptions and itemized deductions. It also avoids any AGI-based limits on charitable deductions.

Not for Iowa:

Therefore, for Iowa purposes, the pre-2006 federal rules would be applicable. The IRA distribution would be included as income on the Iowa 1040 form, even though it is not reported as income on the federal 1040 form. Similarly, the amount of the IRA distribution donated to charity would be reflected as a charitable contribution on Iowa Schedule A, Itemized Deductions, even though it is not reflected on the federal Schedule A.

Worse, you have to do an Iowa-only computation of AGI phaseouts.

As long as the Iowa tax is linked to the federal income tax, it should automatically incorporate federal tax changes. The legislature can then opt out of ones they don't like.

This rule is also ridiculous from a policy standpoint and foolish from a cost-effectiveness standpoint. A sensible Department of Revenue would let this slide.

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Dad's participation isn't your participation

August 18, 2009

Iowa has a special tax break for capital gains on the liquidation of a business or farm that has been held for 10 or more years; taxpayers also have to "materially participate" in the business for 10 years to qualify.

A new ruling by the Iowa Department of Revenue illustrates that while your spouse's participation counts toward the 10-year material participation requirement, you don't get credit for your parents' work:

In this case, the capital gain will be reported by the surviving children. From the facts presented, the children have not been materially participating in the operation of the farm over the immediately preceding ten years. A nephew of the deceased farmer has been cash renting the property over the preceding ten years. The fact that the deceased farmer materially participated until the date of his death does not impact the material participation test for the surviving children. The children have not met the ten year material participation test, so any capital gain from the sale of the farmland would not qualify for the Iowa capital gains exclusion.

The tests for material participation are generally the same as for the federal passive loss rules; they are summarized below. Farmers qualify for special material participation rules for the Iowa capital gains deduction.

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Installment sales and the Iowa capital gain deduction

May 28, 2009

Iowa's "ten and ten" capital gain break eliminates the tax on certain capital gains on property held for ten years by a taxpayer who has also "materially participated" in the business for ten year. The state has issued a ruling explaining how it works for installment sales when the seller dies during the installment period, and the installment receivable goes to a trust with the taxpayer's spouse as the beneficiary:

Therefore, since the taxpayer is still receiving this capital gain income from the trust and the taxpayer met the ten year ownership and ten year material participation test at the time of the installment sale, the taxpayer is still entitled to claim the Iowa capital gains exclusion.

But while that works if the spouse is the trust beneficiary, it doesn't work if the beneficiaries are the materially-participating taxpayer's children:

Finally, you are correct that upon the death of the taxpayer and the subsequent distribution of the taxpayer and trust shares of the capital gains to the children of the deceased, these capital gains reported by the children would not qualify for the Iowa capital gains exclusion since the material participation and holding period requirements were not met by the children at the time of the original sale.

Cite: Policy letter 09201020

Related: IOWA CAPITAL GAINS DEDUCTION: WHAT IS MATERIAL PARTICIPATION?

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Iowa and extender conformity

February 23, 2009

The Iowa Department of Revenue has issued the following e-mail alert (I can't find a link at the Department web site):

The Department has received numerous inquiries related to what are commonly referred to as the federal “extenders” and whether the federal provisions will be adopted for Iowa tax purposes. The extenders include the deductions on line 24 of the IA 1040 for Educator Expenses and Tuition & Fees; also the itemized deduction on Schedule A for state sales and use tax paid.

The final determination on Iowa’s treatment of these items must be made by the Iowa Legislature. The Department made an assumption when printing the 2008 income tax booklet that Iowa would follow the federal treatment. This assumption was based upon past history. In prior years, Iowa has adopted these federal provisions. However, there is no guarantee this will be the case for the 2008 tax year until the Legislature makes its determination. We hope to have that determination by early to mid-March.

If Iowa returns must be filed in the meantime, the Department advises you to complete those returns based upon the premise we will ultimately couple with these federal provisions; with the understanding that an amended return may be required if that premise turns out to be incorrect.

Seeing that they're working nights and weekends at the legislature, you'd think they'd move faster.

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FLOOD TAX URBAN LEGEND

July 01, 2008

Claim: Governor Culver has declared that flood victims in Iowa must pay income tax on debit cards received from the American Red Cross.

Status: False.

Roger McEowen says he has received several calls from attorneys in Cedar Rapids asking if this rumor is true. It isn't.

The debit cards will normally be not subject to income tax under Internal Revenue Code Section 139. Iowa income tax rules follow federal law unless the legislature specifies otherwise, and they haven't. Even if the Governor wanted to tax disaster cards (and why would any politician be that stupid?), he doesn't have the authority do do so.

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INTANGIBLE INCOME TAX NEXUS IN IOWA?

June 12, 2008

Can you be required to pay Iowa corporation income tax if your only presence in Iowa is bits and bytes? A memo released this week by the Department of Revenue says "yes."

The memo deals with a taxpayer that licenses software used to prepare some unspecified government reports to Iowa users. From the memo:

As noted in the example, it does not matter if the fee is considered a royalty or something else. If the fee is received for the use of the software, then it was earned from intangible property located or having a situs in Iowa. Therefore, this activity would be sufficient to create Iowa corporation income tax nexus.

So another happy customer gets to pay Iowa's highest-in-the-nation corporation income tax.

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BAIT, MEET SWITCH

April 23, 2008

The Iowa Legislature has voted to replace the 1-cent local option sales tax with a permanent statewide 1-cent increase in the sales tax. This completes the bait-and-switch. The local-option tax was originally sold as a tax that could be rolled back by the voters if it were no longer needed; it had to be renewed by referendum every ten years. Sorry, suckers!

The Governor is sure to sign the sales tax increase, just as he has signed the statewide increase in vehicle registration fees. After all, Microsoft, Google and Hollywood need the money. And Hormel, and...

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GOVERNOR SIGNS BILL MAKING REBATES IOWA TAX-FREE

March 27, 2008

Governor Culver yesterday signed HF 2417, exempting the federal "stimulus" rebates from Iowa income tax. The Des Moines Register has details.

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IOWA SUPREME COURT: PARTNERSHIP INTERESTS DON'T QUALIFY FOR LONG-TERM GAIN BREAK

March 25, 2008

Iowa has a special tax break for certain business interest sales. If you have held an interest in a business for 10 years and "materially participated" in the business for 10 years, you can exclude the gain on a sale of "substantially all" of the business assets, or business real estate, on your Iowa tax return.

Gaylin Ranniger practiced as a CPA for many years with his partner Morrie Heithoff. In 1992 he sold his 50-percent interest to his partner. He claimed the Iowa "10 and 10" exclusion on his tax return, and the Iowa Department of Revenue disagreed.

The Iowa Department of Revenue rules on the capital gain exclusion provide:

Capital gains from the sale of an ownership interest in a partnership, limited liability company or other entity are not eligible for the capital gain exclusion.


The Iowa Department of Revenue rules on the capital gain exclusion provide:

Capital gains from the sale of an ownership interest in a partnership, limited
liability company or other entity are not eligible for the capital gain exclusion.

Mr. Ranniger argued that the rule was unreasonable, but the Iowa Supreme Court upheld the Department of Revenue last week. The court also said that because Mr. Ranniger's sale only was of half the business, rather than "substantially all" of it, it wouldn't qualify even if partnership interest sales did qualify.

IMPLICATIONS

The case shows that the deck is stacked in the Department of Revenue's favor in court:

Our cases require that exclusions from taxation be “construed strictly against the taxpayer and liberally in favor of the taxing body.”

The Ranniger result isn't surprising given the facts in the case. The Department has been holding other cases in abeyance while awaiting the Ranniger decision. Some of the cases involve the Department's old interpretation of what "held for 10 years" means -- an interpretation based (and I'm not making this up) on a misreading of an out-of-context passage in an old "Master Tax Guide." For you lawyers out there, this is like basing an argument over Iowa statutes on a misunderstood quote from Black's Law Dictionary. The Legislature overturned their strange interpretation for sales after 2005; they now conform to federal holding period rules.

The Iowa Supreme Court says it will overturn a Department rule only if it is "...irrational, illogical, or wholly unjustifiable." The Court had little trouble overturning the state's system of taxing casinos under a similar standard. If the Department maintains its "Master Tax Guide" position on pre-2005 holding-period cases, we'll see whether the Court gives the Department of Revenue more deference than it gives the Legislature.

Cite; Ranniger vs. Iowa Department of Revenue and Finance, Sup. Ct. Iowa, No. 11 / 06-0761

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LEGISLATURE SENDS REBATE EXEMPTION TO GOVERNOR

March 12, 2008

The legislature yesterday passed the bill (HF 2417) to exempt the federal "stimulus" rebate checks from Iowa Income tax. Governor Culver is expected to sign the bill.

Unfortunately, there's no sign that the legislature will conform Iowa tax law to adopt the federal depreciation and asset expensing provisions of the federal stimulus bill, forcing Iowa businesses to keep a separate set of fixed asset records at their own expense. Why? Because Microsoft, Google and itinerent filmmakers are more important to the Legislature than your business and your employer.

Related: IOWA DEPARTMENT OF REVENUE OUTLINES IOWA TREATMENT OF STIMULUS PROVISIONS

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IOWA DEPARTMENT OF REVENUE OUTLINES IOWA TREATMENT OF STIMULUS PROVISIONS

March 10, 2008

The Department of Revenue has posted a tentative summary of how the provisions of the stimulus package will affect Iowa taxpayers. The summary is tentative, as the legislature still hasn't passed the bills that address this. Short version:

- Stimulus payments will be exempt from Iowa income taxes, and
- Iowa probably won't conform to federal depreciation and Sec. 179 changes.

That means Iowa taxpayers can look forward to years of notices asking why Iowa and federal income are different, because Iowa's legislators are more concerned about Microsoft than the businesses that have always been here. Oh, and because the Department of Revenue can't be bothered to design a form that reconciles federal and Iowa taxes, so they issue annoying notices asking taxpayers do do their own reconciliations later.

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GOVERNER GIVES MONEY TO MICROSOFT WHILE HOUSE STIFFS OTHER BUSINESSES

February 29, 2008

Governor Culver yesterday signed the big tax break for the server farm Microsoft has been dangling over the state. Meanwhile, the Iowa House yesterday passed two bills that show their attitude to the businesses that are already here.

The House passed a bill to exempt the federal individual tax stimulus checks from Iowa taxes yesterday (HF 2417). The bill doesn't extend to Iowa the federal bonus depreciation and Section 179 asset expensing provisions of the federal stimulus package; nor does the "code conformity" bill passed yesterday in the House (SF 2123) that otherwise adopts federal tax computation rules to Iowa. In doing this Iowa repeats the mistake it made in failing to conform Iowa to similar provisions in the 2001 stimulus bill, a mistake that required a special session to only partially correct. As a result, taxpayers filing Iowa returns will have to keep different sets of fixed asset records for Iowa at their own expense. They will also have to pay for years of idiotic Department of Revenue notices that the differences between federal and Iowa taxes will cause.

The Moral? The politicians love big, headline generating business openings, but they care a lot less less for the small businesses that don't have lobbyists -- the ones that pay the costs of running the government on behalf of Microsoft and Google.

Related: The Race to Feed Microsoft

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IOWA - TAX BREAKS FOR GIANT BUSINESSES ONLY?

February 17, 2008

The big tax news out of the Iowa Legislature last week was the introduction and speedy passage by the House of HF 2233, the big tax giveaway for Microsoft.

Meanwhile, the Iowa Senate was quietly passing another bill that affects every business that files an Iowa tax return. SF 2123 is the annual bill that updates Iowa's tax computations for changes in the Internal Revenue Code. This one updates Iowa's tax law retroactively to the beginning of 2007 for changes made in the federal law up through January 1 of this year

That's all fine, but the federal government has made an important change in business tax rules not covered by the Iowa bill: the "bonus depreciation" and increased "Section 179" deductions in the economic stimulus bill. Unless Iowa updates its "code conformity" rules, businesses will have to compute depreciation and asset writeoffs using different rules for their federal and Iowa taxes.

WHAT HAPPENED LAST TIME

That happened in 2001 when Congress last tried to goose the economy with bonus depreciation and extra Section 179 deductions. Iowa initially refused to match up with the federal rules. Businesses got so annoyed that the legislature finally conformed to the federal rules in a special 2004 session, but it never did match up the rules for 2001 and 2002. Taxpayers are still battling the Department of Revenue as a result.

The Legislature didn't want to go along with the federal rules in 2001 because they were more generous than the rules they replaced. In other words, they needed the money. They need it even more this year. Last week legislative Democrats announced the death of the Governor's only big revenue-raising proposals, combined corporate reporting and the bottle tax, so it's back to the drawing board to find ways to pay for last year's spending spree. With receipts slowing with the economy, they have a problem.

THE TEMPTATION OF EXTRA REVENUE

The legislature will be sorely tempted to "de-couple" Iowa's depreciation computations from the new federal rules to help raise some of that revenue. While legislative leaders and the Governor have said they won't tax the "rebates" in the stimulus plan, they've so far been silent on the depreciation rules.

If Iowa "de-couples," they will add force every business to spend time and money keeping two extra depreciation schedules, and then answering brainless Department of Revenue notices a few years later when the depreciation computations "turn around" and the Iowa deductions exceed the federal write-offs.

Let's hope the legislature doesn't make the same mistake this year that they made in 2001. So far they find it much more urgent to appease Microsoft than to pass a bill that affects every business in the state.

Follow the progress of tax bills through the Legislature on our 2008 Iowa Tax Legislation page.

UPDATE: They really do want to screw this up:

House Speaker Pat Murphy, a Democrat from Dubuque, says Iowans will not pay state taxes on those federal rebate checks headed their way, but Murphy suggests the state can't afford to be as generous as the feds when it comes to the business tax break for equipment depreciation. "We're not like Washington, D.C. We can't print money," Murphy says. "...We are going to be fiscally responsible. We're going to be prudent. We're going to look at what we can afford to do and what not to do."

Murphy says Democrats who control the legislature's agenda will make a decision about that business tax break "later" -- perhaps as late as 2009. "We're not going to make any guarantees at this point," Murphy says. "...Stay tuned."

If you can't print money, maybe you shouldn't be giving it away to Microsoft and Google.

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IOWA: TAX POLICY FOR A STAGNANT TOMORROW

January 24, 2008

There seems to be no end to the devotion of Iowa's political class to the ag industry. Let some administrative agency look cross-eyed at farmers, and a host of Iowa Senators and Represenatives rises up to smite the offending bureaucrat. Short of establishing the Cult of the Corn God as Iowa's state religion, there's not too much left for row crop lobbyists to ask from our elected representatives.

Other industries, not so much. And that's puzzling, when you consider what Iowa's biggest industries are, as a percentage of its economy (2006 figures, courtesy of the Federal Reserve Bank of Chicago):

  Finance, Insurance and Real Estate: 21.3%
  Manufacturing: 21%
  Services: 16.2%
  Wholesale and Retail: 13.9%
  ...
  Agriculture, Forestry, Fishing and Hunting: 3.3%

As the chart below shows, agriculture is much less of the Iowa economy than it was in 1980, while financial industries have become much more important.

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Source: Federal Reserve Bank of Chicago. Click chart for larger image.


While Iowa's economy has moved on, the Iowa Department of Revenue and Finance is still partying like it's 1979, at least when it comes to how it taxes investment partnerships.

Partnerships have become an everyday tool in the financial world. The entire hedge fund industry is built around investment partnerships. The private equity world loves partnerships. They allow ownership and allocation flexibility without incurring extra layers of tax.

Except in Iowa.

HOW IOWA TAXES INVESTMENT PARTNERSHIPS

The Iowa Department of Revenue takes the position that investment income of non-resident partners of Iowa investment partnerships is fully taxable in Iowa as "business income." That means a Florida investor in an Iowa investment partnership is expected to pay Iowa tax of up to 8.98% on his share of a dividends, interest and capital gains earned through an Iowa partnership - income that would be free of state income taxes if he earned the money directly.

State tax laws generally distinguish between "business" and "non-business" income. Iowa can tax Iowa business income earned by residents of other states, but non-business income is taxed only by the resident state. Iowa's tax regulations recognize this principle using an example of a farm operation that also has a savings account; the interest earned on the account is non-business because the account isn't used in the day-to-day operations of the business.

The Department of Revenue makes this regulation meaningless for partners by defining all partnership income as business. Their justification? They cite the non-tax definition of "partnership" in the Iowa statutes, which says a partnership is "an association of two or more persons to carry on as co-owners a business for profit." (their emphasis). So the same savings account that is "non-business" for the farmer becomes "business" once the farmer takes on a partner. This is all spelled out in a 1992 "Letter of Findings" ( Re Herman A. & Veneta L. Jensen).

This is absurd.

The Department's position doesn't even make sense on its own terms. While Iowa's partnership statute refers to operating "for profit," the parallel laws for limited liability companies and corporations merely refer to "any lawful purpose." By Iowa's logic, then, an LLC or S corporation should be able to have non-business income; even so, the Department of Revenue insists that investment LLCs and S corporations generate "business income," just like partnerships.

The Iowa Supreme Court has rejected the implication that a pass-through entity can't have non-business income in the Comacho case, though the taxpayers lost on the facts.

OTHER STATES DON'T TRY TO TAX NONRESENTS ON PARTNERSHIP INVESTMENT INCOME

New York state uses language identical to Iowa its tax law defining business and non-business income, but, tellingly, they don't try to tax non-resident partners on their investment income. Not coincidentally, there are hundreds of hedge funds based in New York. If there are any in Iowa, I haven't seen them.

Why does the Department do this? I'm guessing it's because the state needs the cash, and because they can get away with it. For most non-resident partners, the tax involved is too small to make it worth hiring a lawyer to fight. More importantly, anybody who has enough partnership income to fight over is staying out of Iowa altogether.

So in the pursuit of a few pennies from non-resident partners, the Department stifles a critical tool of the industry that provides 20% of the state's economy and much more than 20% of its growth. Meanwhile, Iowa's politicians, who should be all over the Department for this, instead look to beat up even more on non-resident taxpayers.

Many states, including California and Illinois, have laws that exempt non-resident partners of investment partnerships from their income tax; Iowa is one of the few states that even tries to tax nonresidents on investment partnership income. It's especially sad when Iowa's laws already exempt such income, but the Department of Revenue insists otherwise. But so far our Legislature is more interested in subsidizing Hollywood than in removing tax shackles from Iowa's most dynmamic economic sector.

Maybe it's just a branding issue. If partnerships were to call themselves, say, "corn heritage funds," the legislature might leap into action.

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IOWA AMNESTY FIZZLES; IT'S MY FAULT

November 02, 2007

It looks like the Iowa Tax Amnesty has fallen far short of its authors' expectations, says the Des Moines Register:


A program that temporarily allowed Iowans to skip all penalties and half of their unpaid interest on delinquent taxes collected less than 25 percent of what state officials had predicted, preliminary estimates show.

The program, known as tax amnesty, ended at midnight Wednesday. State officials had hoped to collect $54 million in the program that began Sept. 4. As of Thursday, they had collected $13 million.

Practitioners who have worked with both amnesties say that the one that ended Wednesday was much less attractive than the 1986 version. The Branstad amnesty allowed taxpayers to continue to contest their tax liability if they paid under the amnesty; the Culver amnesty requires the taxpyer to surrender on contested issues. That's why the Branstad amnesty was able to raise $35 million, while the Culver one hasn't acheived half that amount in inflated 2007 dollars (of course, the Branstad $35 million was probably overstated, as some taxpayers were surely successful in their challenges).

But House Majority Leader Kevin McCarthy says the real fault is with critics of the amnesty, like the Tax Update and House Minority Leader Rants:

House Majority Leader Kevin McCarthy, a Des Moines Democrat, blamed the skimpy collection in part to "over-the-top and fairly reckless statements" from opponents of the program, who had called it a "tax break for tax cheats."

Right. People didn't take advantage of the amnesty because of those of us who pointed out that it makes chumps out of folks who pay their taxes, or who came forward to get out of trouble before the amnesty was enacted. That intimidated people who would otherwise straighten out their taxes. Who knew that people who don't pay their taxes were so sensitive?

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AMNESTY COMING UP SHORT?

November 01, 2007

The Iowa Tax Amnesty ended on Halloween. So far the state hasn't filled its trick-or-treat bag:

The program, known as tax amnesty, ended at midnight Wednesday. State officials had hoped to collect $54 million in the program that began Sept. 4. As of 10 a.m. today, they had collected less than $10.5 million.

State revenue employees will continue to accept payments that were postmarked by the deadline, which could boost the total to as high as $16 to $20 million, said Stuart Vos, who is heading the amnesty program for the Department of Revenue.

Which state officials thought they would collect $54 million? It would to know who missed the mark so badly.

The state collected $35 million in the amnesty program in 1985, the last time it was used.

And the last time it was used, you could pay under the amnesty and still contest the tax. The new amnesty didn't let you do that. And they're surprised it's less popular now?

The next amnesty program cannot take place before 2025, according to state law.

Unless, of course, they enact another amnesty.

The current state budget counts on $16 million from the amnesty. It looks like even that will be a close call.

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PUMPKIN AMNESTY

November 01, 2007

20071101-1.JPGBowing to nationwide ridicule, the Iowa Department of Revenue reversed itself on the contentious pumkin tax yesterday. The Department had ruled that pumpkins purchased for carving would be subject to sales tax, but those purchasing pumpkins for food could get a sales tax exemption by filling out an exemption form.

Now we can turn our attention to another gross sales tax injustice: the disparate treatment of Milky Way bars.

The Iowa sales tax law says the following about candy:

"Candy" means a preparation of sugar, honey, or other natural or artificial sweeteners in combination with chocolate, fruits, nuts, or other ingredients or flavorings in the form of bars, drops, or pieces. Candy shall not include any preparation containing flour and shall require no refrigeration.

The ingredients in the classic Milky Way bar:

MILKY WAY® Bar ingredients: milk chocolate (sugar, cocoa butter, skim milk, chocolate, lactose, milkfat, soy lecithin, artificial flavor), corn syrup, sugar, partially hydrogenated soybean oil, skim milk, less than 2% milkfat, cocoa powder processed with alkali, lactose, malted barley, wheat flour, salt, egg whites, artificial flavor

20071101-4.jpg
Tax-exempt.

The ingredients in the Milky Way Midnight Bar:

MILKY WAY® MIDNIGHT® Bar ingredients: semisweet chocolate (sugar, chocolate processed with alkali, cocoa butter, chocolate, milkfat, soy lecithin, vanilla extract, artificial and natural flavors), corn syrup, sugar, skim milk, partially hydrogenated soybean oil, less than 2% butter, milkfat, lactose, salt, egg whites, vanilla extract, artificial flavor.

20071101-5.jpg
Taxable.

So: Milky Way Midight: subject to Iowa sales tax. Milky Way classic: exempt in Iowa.

No justice, no peace!

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HAPPY HALLOWEEN!

October 31, 2007

But not if you sell pumpkins in Iowa.

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The Department of Revenue has cracked down on jack-o-lantern scofflaws:

The Iowa Department of Revenue is taxing jack-o'-lanterns this Halloween. The new department policy was implemented after officials decided that pumpkins are used primarily for Halloween decorations, not food, and should be taxed, said Renee Mulvey, the department's spokeswoman.

"We made the change because we wanted the sales tax law to match what we thought the predominant use was," Mulvey said. "We thought the predominant use was for decorations or jack-o'-lanterns."

Previously, pumpkins had been considered an edible squash and exempted from the tax. The department ruled this year that pumpkins are taxable — with some exceptions — if they are advertised for use as jack-'o-lanterns or decorations.

Iowans planning to eat pumpkins can still get a tax exemption if they fill out a form.

State 29 has more.

And speaking of scary, today is the last day to apply for the Iowa Tax Amnesty.

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$5 MILLION DOWN, $11 MILLION TO GO

October 30, 2007

The Iowa Tax Amnesty ends tomorrow. The Cedar Rapids Gazette reports that 3,000 taxpayers have taken advantage of the program, paying over $5 million in back taxes. The state is counting on $16 million in revenue from the program for the current fiscal year budget.

Delinquent taxpayers using the amnesty avoid prosecution and penalties, and pay only half the normal interest rate. Those who pay their taxes on time every get a big "Thanks, Chump!" from the state.

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IOWA TAX AMNESTY: $2 MILLION DOWN, $14 MILLION TO GO

October 08, 2007

The Iowa Tax Amnesty has so far raised $2 million of the $16 million in tax revenue that the state budgeteers are counting on. Presumably the bulk of the revenue will come in during the last week of the 2-month amnesty period that ends October 31.

There are no figures yet for the amount of revenue to be lost in the future to taxpayers who will expect Iowa to go for another amnesty the next time a new governor wants to spend some money.

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IOWA LEGISLATURE PLOTS LAMENESS

September 12, 2007

20070912-3.jpg
Speaking of clueless tax policy in a place where the population has been migrating away for some time, the Iowa legislature is pondering its moves for the next legislative session. It looks like more of the same:


House Speaker Pat Murphy, D-Dubuque, was optimistic that lawmakers would address the state's property tax system, even if only in a limited fashion.

Commercial property tax rates are at the heart of the issue. All sides agree that Iowa's commercial rates are out of line with other states, but resolving the problem without shifting the burden to either farmland taxes or residential rates has been difficult -- lawmakers couldn't agree on a solution last session.

"I think we will do something this session," said Murphy. "We may not do something statewide, but we may get some pilot projects started that would be very beneficial."

Oooh, a pilot project! Expect the "pilots" to be well-connected at the statehouse.

Like in Mexico, the Iowa politicians may have their eye on gas tax increases:

Lawmakers could look in a limited number of places for highway construction -- primarily gasoline taxes, vehicle registration fees or license fees. Murphy added another potential source to the mix: a "severance tax" on renewable fuels.

"Why not do it like Texas?" Murphy asked. "Texas has a tax on fuel when it leaves the state so consumers throughout the United States pay for their education system."

Brilliant. Subsidize ethanol with one hand, tax it with the other. I can hardly wait for the legislature to convene to show off their bold leadership again.

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IOWA TAX AMNESTY UNDER WAY

September 05, 2007

The Des Moines Register reports that the Iowa Tax Amnesty collected $150,000 in back taxes by early in the day yesterday, the first day of the program. Taxpayers have until October 31 to pay back Iowa taxes without penalty and at a special 1/2 interest rate.

It applies to most taxpayers who owe back Iowa taxes. The exceptions:

The program does not apply to taxpayers currently under active criminal investigation, to taxpayers who are part of a criminal proceeding pending in the Iowa court system, or to those with settlement agreements. Amnesty will also not apply if you have a settlement agreement with the department.

You should contact a tax pro if you want to take advantage of the amnesty, but for do-it-yourself-ers, here is an application form.

You can learn more at www.iowataxamnesty.gov.

And for those of you who paid your taxes on time all these years? The State of Iowa says "thanks, chumps!"

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HOW HAROLD HILL CLAIMS HIS IOWA FILM CREDITS

August 22, 2007

hh44.jpgThe Iowa Department of Revenue has proposed rules for the film industry tax breaks enacted this spring. There are two main sets of breaks -- an exclusion from income for taxpayers who provide goods and services for filmmakers, and a tax credit for 25% of the filmmakers costs. The credit can be sold, so the credit functions as a cash subsidy for filmmakers.

The credit will be claimed by submitting a new Iowa "Form Z" listing the film expenses to the Iowa Film Office. The production company can then sell the 25% credit at a discount to cover its own costs.

No other industry gets such a double-barreled break. So next time you write a check to Iowa to pay taxes so Tom Arnold doesn't have to, remember: out-of-state filmmakers are more important to the Legislature and the Governor than you are.

The proposed rules are here; scroll about halfway down or search "film" on your browser.

Link: Complete Tax Update Film Credit Coverage.

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TAX CREDITS AND THE RIPPLE EFFECT

August 20, 2007

20070820-1.jpgThe Des Moines Business Record examines Iowa's 33 tax credit programs in a piece called "The Ripple Effect." It's an appropriate title, as economic development credits are to economic development as Ripple wine is to healthy hydration.

The Business Record piece isn't shy about drawing conclusions; the author thinks that they just magically create jobs:

It's hard to argue with incentive programs that lead to hundreds of millions or even billions of dollars in new capital investment and the creation of thousands of new jobs in the state. The investments spurred by tax credit awards have been particularly valuable to many of Iowa's rural communities, said Michael Tramontina, director of the Iowa Department of Economic Development.

Actually, it's not that hard to argue with them. The argument starts with the idea of "opportunity costs." The piece says that there have been $1.23 billion of economic development credits issued over the past ten years. What else could have been done with that money? What if it had been left in the hands of the taxpayers, instead of doled out to well-connected businesses? What if it had been used to keep a key highway bridge from falling down?

Another issue is whether the credits reward taxpayers for things they would already do. While the economic development folks always claim responsibility for projects that get credits, many, perhaps most, of those projects would have happened anyway. The recent changes in Iowa's rehab tax credit actually issued new credits for rehabilitation work that had already been done.

The piece quotes economic development director Tramontina:

"You really have to consider how big those (ethanol plant) investments are," he said. "For a rural county to get an investment of $175 million to $225 million, that's more than the equivalent of adding an 801 Grand (building) in one of those counties." The dollar amount of the tax credits awarded to those plant projects has averaged about 7 percent of the total private investments, he said.

Time will tell whether this was a benefit. If these ethanol plants end up bankrupt and shuttered in a few years - a very real possibility, as they can survive only as long as they are richly subsidized by the taxpayers - all of these economic development funds will turn out to have been poured down a rathole.

The whole idea of tax credits implies that statehouse politicians are some kind of economic supergeniuses who can funnel taxpayer funds into the optimal economic activity for the state -- or at least better than private equity and credit markets. That's ridiculous. If they were so smart, they would be making millions as investment bankers rather than $21,380 as state legislators.

That doesn't bother the politicians:

What isn't slowing is the pace at which tax credits are being claimed. State officials estimate that by 2011, businesses and individual taxpayers will claim about $400 million in credits against their taxable income, compared with $157 million in credits actually used in fiscal 2004, the latest year for which data is available.

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As a recent report by the State Auditor's office shows, these credits often fail to meet their hype. For example The report showed that of 30,732 "pledged" jobs from the Grow Iowa Values fund credit program, only 13,730 had really been pledged under the terms of the program, and many of those were receiving other funding.

Bottom line? Economic development credits make Iowa business and employees that lack good statehouse connections pay higher taxes to lure and subsidize their wired-in competitors.

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YEPSEN ON TAX REFORM

May 21, 2007

Des Moines Register columnist David Yepsen takes on the Iowa tax system. He is correct in noticing that we have a problem, but his solution just scratches the surface.

Mr. Yepsen suggests a big bipartisan solution:

One device for doing that would be to call a political "summit" to be held this summer and fall. Culver would bring together key lawmakers and interest groups in an effort to forge a compromise tax-reform plan to submit to the Legislature next January.

This has little hope because the Governor is committed to an anti-tax reform agenda of special interest tax breaks. Until those go on the chopping block, there's not much to talk about.

What might a compromise change look like?

- Income tax. Iowa could get rid of federal deductibility and adopt lower but graduated rates. (Liberals and business recruiters win.) Or, Iowa could adopt a flat or two-rate tax system. (Conservatives and business recruiters win.)

Mr. Yepsen misunderstands the dynamics of "business recruiters," the local and state "economic development professionals." They like high rates and loopholes because they peddle special interest tax credits. If you have a simple, low rate tax system, they become redundant, because businesses no longer have to be bribed to come to Iowa.

To protect taxpayers from future rate increases, a constitutional supermajority vote of the Legislature or a vote of the people could be required for future tax increases. (Conservatives win.)

Better still would be a constitutional limit on the growth in state government, based on population and economic growth. Just a dream, I know.

Each income-tax credit and deduction should be examined to see if it is doing what was intended. (Liberals win.)

Eh? Not so much. Tax credits are backdoor industrial policy, which is what liberals are all about. Witness the witless biofuel, film and investment subsidies that flew through the last session of the legislature. About the only liberal who stands up against these giveaways (with rare exceptions) is Ed Fallon, and he's not even in the legislature anymore .

Mr. Yepsen also has a strange take on sales taxes:

And it might be good tax policy. According to the Iowa Taxpayers Association, Iowa's sales-tax burden ranks 33rd among the 50 states per $1,000 of personal income. That's below average. But Iowa's property tax ranks 17th, which is above the national average.

So, it makes sense to increase a below-average sales tax that people don't mind paying to relieve the property tax they hate - and that perhaps impedes economic growth.

If we have a low sales tax burden, it's not because we have a low rate. We already have a relatively high rate at 6%, and a 7% rate would give us the highest in the nation.

One thing Mr. Yepsen says is absolutely true:

Just as it took several years to win approval of a cigarette-tax increase, it might take several years to win a rewrite of the tax code, because it might take that long for people to understand the change and grow comfortable with it.

Every special interest credit, from ethanol to rehab credits to film subsidies, creates a vocal constituency against change. Until these giveaways are ended, a simple system with lower rates is impossible. Only strong leadership by the Governor, maintained over a period of years, can prevail. It doesn't seem likely anytime soon.

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COMBINED REPORTING: WHAT THE NEW IOWA RULES WILL DO

March 01, 2007

The legislature is likely to pass combined corporation reporting this year. It's part of the governor's budget, and bills arre in the hopper in both the Iowa House (HF 326) and the Iowa Senate (SSB 1074).

The bills would apply to groups eligible to file a federal consolidated return. They attempt capture income steered to affiliated corporations in low-tax states by means of management fees and other intercompany income-shifting devices.

Example: Roy, Inc. is incorporated in Delaware; it has no Iowa nexus (taxable presence) and Iowa sales are $0 of its $90 million gross receipts. It has taxable income of $1 million, aside from management fees. It owns 100% of Gately Inc.

Gately has Iowa nexus. It has $5 million Iowa sales of its $10 million gross receipts. It has net income of $1 million before management fees. Gately pays Roy Inc. management fees of $1 million.

Without combined reporting, Gately allocates 50% ($5 mm $10 million) of $0 net income to Iowa and pays $0 tax.

With combined reporting, the Roy Inc. group allocates 5% ($5 mm $100 mm) of $2 million of income to Iowa, resulting in approximately $10,100 in Iowa tax.


A bolder and wiser move would be to repeal the state corporation income tax, which contributes insignificantly to Iowa's tax revenues (@3%), even though it imposes the highest tax rate of any state - 12%. Boldness and wisdom aren't in surplus this year, it seems.

We are tracking all tax bills in the legislature at our 2007 Iowa Tax Legislation page.

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IT'S OUR DESTINY: IOWA NEAR TOP IN INCOME, SALES TAX RATES

February 15, 2007

The Tax Policy Blog has a post linking a number of state-by-state tax comparision charts. You can go here for the corporation income tax rates, individual income tax rates, sales tax rates, and property tax and tax burden comparisions.

Iowa has the highest corporate rate in the country, at 12%, and the 5th highest individual tax rate, at 8.98%. Sure, we we get lots of special interest breaks and federal deductibility, but that just means we have a lot of complexity to go with our high rates.

The highest sales tax rate among the states is 7%, in Mississippi, Tennessee, Rhode Island and New Jersey. Central Iowans will vote on whether to join this elite group in the "Project Destiny" referendum this spring. With all Iowa counties now having a local option sales tax, we have a 6% statewide sales tax rate. The 1-cent Project Destiny tax will put central Iowa in the same 7% league as Tupelo and Newark for economic and cultural dynamism.

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IOWA CORPORATION COMBINED REPORTING BILL INTRODUCED

February 14, 2007

The bill to impose combined reporting of income of "unitary" corporations filing consolidated returns (HF 326) has been introduced in the Iowa House. It's a key part of the Governor's budget and seems certain to pass. From the bill explanation:

This bill requires that the net income of affiliated groups of corporations engaged in a unitary usiness be computed on a combined return basis for corporate tax purposes if the group meets the requirements for filing a consolidated return for federal tax purposes. The affiliated group would include corporations with common ownership whereby one or more corporation sown 80 percent or more of another corporation. The bill would require that one Iowa corporate income tax return be filed that would include all unitary members of an affiliated group. Any nonunitary member that is subject to Iowa tax would file its own separate corporate return. Only Iowa sales of those corporations doing business in Iowa would be included in the numerator of the Iowa sales ratio. The bill also provides that only those corporations doing business in Iowa are jointly and severally liable for the tax of the combined return.

The bill applies retroactively to January 1, 2007, for tax years beginning on or after that date.

Because the bill is retroactive, it will affect estimated tax payments this year for many coporations.

Track all Iowa 2007 tax legislation at our 2007 Iowa Tax Legislation page.

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IOWA TAX AMNESTY BILL INTRODUCED

February 08, 2007

The legislative language of the tax amnesty proposed in Governor Culver's budget was introduced in the Iowa Senate this week. From the bill explanation:

This bill provides for a state tax amnesty program to be administered by the department of revenue from September 4, 2007, through October 31, 2007. The program covers tax liabilities delinquent as of December 31, 2006, and authorizes a taxpayer, during the period of the tax amnesty program, to pay this tax with one=half of the interest which would ordinarily be due without being subject to further penalty or civil and criminal prosecution. The taxpayer must agree to relinquish all administrative and judicial rights to challenge the imposition of the tax and its amount.

The taxes that are covered under the tax amnesty program are the individual and corporate income taxes; franchise tax; sales and use taxes; hotel and motel tax; local city, county, and school district sales and services taxes; automobile rental tax; equipment tax; petroleum diminution charge; inheritance and estate taxes; motor fuel and special fuel taxes; cigarette and tobacco taxes; and controlled substance tax.

This is likely to pass, as the legislature's desire to have a bit more money right now will trump the interests of sound tax policy. If you have unpaid taxes that Iowa hasn't noticed, you'd be crazy to 'fess up before this bill is signed. If you have been paying your taxes on time, well, you are allowed to feel a bit like a sap now. Meanwhile, Iowa is setting a pattern for tax amnesties every 20 or so years.

You can follow the progress of all 2007 Iowa tax legislation at our 2007 tax legislation tracking page.

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BEG YOUR PARDON, GOV'NOR

January 31, 2007

The Des Moines Register has some new details about the proposed Iowa tax amnesty:

Under an Iowa Department of Revenue proposal, Iowans would be given roughly a two-month window of opportunity - from Sept. 4 through Oct. 31 - to pay delinquent taxes that are free of penalties, and with a 50 percent reduction in the amount of interest due.

The amnesty would cover the state income, sales, cigarette and motor fuel tax as well as other types of taxes collected by the state government. However, the program would not include property taxes or liquor taxes.

As a cheap gimmick to raise revenue, it's a bad enough idea to get support from both sides of the aisle:

Leaders of the 2007 Legislature agree it's worth a try to offer a new tax amnesty program - one of the budget recommendations that Culver, a Democrat, made Tuesday.

"I think it's a good thing to do. You don't have enough enforcement to catch everyone," said Senate Minority Leader Mary Lundby, a Marion Republican. "If you have an amnesty and get some money back from it, why not try it?"

This, of course, sends a bold bi-partisan message to the taxpaying public: "So you've paid your taxes on time all these years? Ha, ha, ha, Sucker!"

Prior coverage:

AN IOWA TAX AMNESTY?

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IOWA CAPITAL GAINS DEDUCTION NOT REDUCED BY OTHER LOSSES

December 18, 2006

An email to preparers from the Iowa Department of Revenue has this nugget:

Capital Gains Deduction: Beginning January 1, 2006, Iowa follows Federal holding period rules. The material participation requirements have not changed.

In addition to the legislative change, the department has revised its position on another aspect of the capital gains deduction. Previously, the department had taken the position that in order to claim a capital gain exclusion for individual income tax, a taxpayer must be in a net capital gain position on the federal return. If a taxpayer was in a net capital gain position, then the capital gain exclusion could exceed the capital gains reported on the federal return if the qualifying gain was offset by non-qualifying capital losses (such as stock sales). After a review by the Attorney General's office, the department has changed its position on this issue and will allow a capital gain exclusion from qualifying gains even if the taxpayer was in a capital loss position on the federal return.

This is helpful. If you have a big capital gain, standard tax planning suggests that you harvest capital losses in your portfolio to offset them on the federal return. Now it is clear that doing so won't cost you your Iowa "10 and 10" capital gain exclusion. This exclusion applies to sales of business land and assets if you have "materially participated" in the business for 10 years and have held the property for at least that long.

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IOWA: CRP 'MATERIAL PARTICIPATION' FOR CAPITAL GAIN EXCLUSION

October 31, 2006

Unlike the federal government, Iowa has no special tax rate for long-term capital gains. For a few taxpayers, though, it has something much better: a complete exclusion from income for long-term gains. Very long term.

Iowa allows taxpayers to exclude gains where they meet two ten-year requirements:

- The gain is on business property held for at least ten years; and

- The taxpayer "materially participated" in the business for ten years.

For retired farmers, there is a special rule: you are considered to have "materially participated" in any year if you materially participated for five of the eight years you farmed before retirement. "Material participation" is generally determinined under the federal tax law's "passive activity" rules.

Yesterday the Iowa Department of Revenue released a policy letter holding that participation in the Conservation Reserve Program (CRP) counts as "material participation." The fact pattern from the policy letter:

The situation posed in your letter involves farmland that was owned by the taxpayer for 41 years, the last 18 years as part of an S corporation. The taxpayer farmed the land until 18 years ago when it was put into CRP (Conservation of Reserve Program) for 10 years. The land was then taken out of CRP and farmed for one year, and then was put back into CRP seven years ago. The taxpayer retired three years ago, and has been cash renting his remaining land since retirement.

Citing two private letter rulings, the Department ruled that CRP participation counts as material participation, and the retired farmer was allowed to sell his farmland at a gain without tax.

So - if you are being paid to not farm, you are materially participating in farming. Is this a great country, or what?

Related:

IOWA'S REALLY LONG-TERM CAPITAL GAIN DEDUCTION

IOWA'S SUPER-LONG TERM CAPITAL GAINS DEDUCTION: IF YOU QUIT, DON'T WAIT TOO LONG TO RETIRE

You can find a recap of the basic rules defining "material participation" below in the extended entry.

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LOW RATES VS. TARGETED TAX BREAKS IN SIOUX CITY SENATE RACE

October 27, 2006

If you're looking for a lab experiment on whether low tax rates are better for economic health than high tax rates with lots of targeted incentives, you don't have to look past Sioux City, Iowa. Sioux City "enjoys" Iowa's 8.98% top individual rate and our highest-in-the-land 12% corporate tax rate. This tax misery is treated with over 20 economic development tax credits under Iowa law.

Across the river, Sioux Falls, South Dakota has no income tax credits to offer; they have no personal or corporate tax at all.

These two approaches to tax policy are the focus of a State Senate race in Sioux City. From the KTIV website:

Thursday night, Republican Barbara Blanchard squared off with Democratic incumbent Steve Warnstadt on this and other issues, at a candidate forum sponsored by the League of Women Voters.

Both Barbara Blanchard and Steve Warnstadt say they have a solution to make Iowa more attractive to business.

While Blanchard says Iowa needs to lower corporate and property taxes to stay competitive with border states like South Dakota, Warnstadt says Iowans need to turn to Ethanol for job growth.

Yes, that will help us compete with South Dakota; they don't grow any corn there, do they? Corn alcohol is only a cure for Iowa's economy if you're a bartender.

It will create jobs that will not be exported. That can't be said for a lot of other industries. The state needs to take a leading roll. There's other tax credits that we could be pursuing in a targeted way, such as historic preservation tax credits, that would again be a boon to Sioux City," says Warnstadt.

If tax credits would be a "boon" to Sioux City, why is Sioux City not booming with the historic preservation credits and 20+ targeted tax credits we already have?

Blanchard disagreed saying, We haven't begun to become competitive with South Dakota. We absolutely have to here in Northwest Iowa, go for zero corporate taxes. We have begun with some tax incentives. Those are going to wear out eventually, or have to be renewed and they are not going to be competitive with the zero corporate taxes in South Dakota."

Anybody who advocates more targeted tax incentives should have to explain just how many more it will take.

Related: IOWA'S TAX CLIMATE: STILL IN THE BOTTOM TEN

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IOWA'S TAX CLIMATE: STILL IN THE BOTTOM TEN

October 11, 2006

Iowa retains its firm hold as one of the states with the 10 worst business climates, according to a new report by the Tax Foundation.

The Foundation's State Business Tax Climate Index rated Iowa's business tax climate 43rd out of 50 states this year. We are a hair ahead of Nebraska, but a mile behind #2-rated South Dakota.

sbtci2007.JPG
Click to enlarge.


How did Iowa get such a lame ranking? Consider what the Foundation uses as criteria for a good tax system:

Good state tax systems levy low, flat rates on the broadest bases possible, and they treat all taxpayers the same. Variation in the tax treatment of different industries favors one economic activity or decision over another. The more riddled a tax system is with these politically motivated preferences the less likely it is that business decisions will be made in response to market forces.

Without "politically motivated preferences" Iowa would hardly have an income tax. And it looks like our candidates for governor like that just fine.

The top 10 states in the rankings were:

1. Wyoming
2. South Dakota
3. Alaska
4. Nevada
5. Florida
6. Texas
7. New Hampshire
8. Montana
9. Delaware
10. Oregon.

Our companions at the bottom of the barrel:

41. Minnesota
42. Maine
43. Iowa
44. Nebraska
45. California
46. Vermont
47. New York
48. New Jersey
49. Ohio
50. Rhode Island.

The Foundation also has a piece on their site linking tax climates and economic growth. They note:

In fact, between 2000 and 2005, income in the top 10 states in the 2007 Index grew 44 percent faster than in the bottom 10 states. Employment in the top 10 states grew 115 percent faster, output 52 percent faster and population 164 percent faster.

Yet our candidates for governor think that what we really need are more tax breaks for old folks and more targeted tax credits. Look out, Nebraska!

UPDATE: Chris Atkins from the Tax Foundation sends us specifics on why Iowa has a rotten tax climate.

Tax Foundation Tax Climate Links:

Background Paper

Full Study (pdf)

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GOVERNOR CANDIDATES: SAME OLD, SAME OLD

October 10, 2006

Iowa's two major party candidates for governor had their first debate. Any voters looking for a new direction for Iowa's tax policy will need to wait at least another four years.

From the Des Moines Register:

Democrat Chet Culver and Republican Jim Nussle disagree on whether Iowans ought to be able to vote on major tax increases, one of several markers in the candidates' limited tax plans.

Neither candidate for Iowa governor has proposed wholesale changes to Iowa's tax law. Both have said they would leave the heavy lifting of restructuring the tax system to the task forces each has proposed be convened after the election.

Punting an issue to a "task force" shows that the candidate has no serious thoughts on tax policy of his own. If you need a panel to give you a policy approach, you haven't done much thinking for yourself.

NUSSLE: MORE LOOPHOLES FOR OLD FOLKS

"If I come out with a tax-cut plan ... half the Legislature will be against it. So I start off with one foot in the hole," Nussle told Des Moines Register editors and reporters.

Nussle has said he would earmark about one-third of surplus revenue for tax relief. It would be up to a commission, chosen by Nussle and the Legislature, to recommend how to apply it, Nussle said.

That's leadership for you...

He has also suggested eliminating taxes on Social Security and pensions in Iowa, saying they prompt Iowa seniors to leave the state.

Of course, the resulting high taxes on those of us still working prompt businesses to stay the heck out of the state.

CULVER: MORE TARGETED LOOPHOLES

Culver supports getting rid of federal deductibility, which would raise the tax burden on some Iowans, while Nussle supports keeping it.

Culver has proposed $40 million in property tax relief through increasing state aid to schools. He would also seek to allow more Iowans to receive the state's earned-income tax credit, estimating $21 million in income tax relief to low- and middle-income families.

He has also proposed tax credits for child care and to promote energy conservation.

Still more social policy through the tax law.

Culver says his tax proposals could be financed through $1 billion he estimates would be available through surplus revenue, a higher tobacco tax and savings achieved by gutting government of waste.

More government, less waste. That's sort of like saving gas by buying a bigger car.

And what about Iowa's highest-in-the-nation corporate tax rate? Or our state tax law that rivals California and New York in baroque complexity? Our high individual tax rates? Our 20-plus targeted tax credits for the well-connected? We'll just have to wait for the "task force" to complete its doomed-to-be-ignored study.

Additional Links:

Radio Iowa Coverage of Culver Tax Plan

Related Tax Update Coverage:

OLDSTERS THRASH WHIPPERSNAPPERS

TAX FOUNDATION: IOWA NINTH WORST STATE FOR BUSINESS TAXES

DES MOINES REGISTER HIGHLIGHTS TAX INCENTIVES

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IOWA: REMAINDER INTERESTS DON'T QUALIFY FOR TEN-YEAR GAIN EXCLUSION

September 13, 2006

When Myron Hass's father died in 1964, he left his widow with a life estate in some Sioux County farmland. Myron and his three siblings were left a remainder interest - they would get full title upon the death of Myron's widow.

Myron farmed the land until his mother's death in 2001. He sold the land in 2002 and claimed Iowa's super-long-term capital gain exclusion. This provision allows taxpayers to exclude from income capital gains from property held for 10 years if they meet certain "material participation" requirements.

This week the Department of Revenue released a ruling that the ten-year holding period didn't begin until Myron's mother died in 2001. Result: no capital gain exclusion.

Related: FARMERS AND ULTRA LONG-TERM CAPITAL GAINS

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HOW SOFTWARE DEVELOPERS FIND THEMSELVES TAXED IN IOWA

June 29, 2006

The Iowa Department of Revenue this week released a letter responding to a software developer's questions about Iowa taxes. It shows how little contact a company needs in Iowa to be taxable here. It's also worth looking at because other states apply similar standards to drag companies into their income tax system. Public Law 86-272 is the federal statute that sets the bar for when you are subject to income tax in the state. The way Iowa applies the rules, taking care of your Iowa customers can have unpleasant tax side effects.

The facts:

Your scenarios assume that the software developer does not have an office in Iowa or a permanent sales staff in Iowa. The software is not sold, but the developer licenses the right to use software to an end user. As part of the transaction, the software developer may or may not send someone to the users office for installing the software and training the user on the software. The developer also contracts to provide continuous support and maintenance to each customer, and the contract typically breaks out a separate fee for each service.

So - does simply licensing software for use in Iowa make you taxable here? No:

The mere grant of the right to use the developers software does not, by itself, create Iowa corporation income tax nexus.

OK, what if you actually provide service to a customer? Bad news:

Sending an employee into Iowa to install and/or train the use does create Iowa corporation income tax nexus. As noted previously, the protection of Public Law 86-272 does not apply in this instance, so any physical presence in Iowa by an employee of the software developer is sufficient to create corporation income tax nexus.

Even if you only send them in for a day?

There is no minimum period of time needed to be in Iowa to create corporation income tax nexus. As noted previously, the de minimus exception in Public Law 86-272 does not apply in this instance, so any period of time spent in Iowa is sufficient to create nexus.

This can create unpleasant results. Iowa apportions taxable income here based solely on sales; most states also take property and payroll into account. That's a great formula for Iowa-based companies, but it can make non-Iowa companies taxable quickly at rates up to 12% - the highest in the nation.

The entire contract with an Iowa customer will be considered an Iowa receipt for corporation income tax purposes. Once nexus is established, the entire amount of income received from an Iowa customer will be considered Iowa receipts.

Well, Mr. Software Company won't ever make that blunder again; they'll avoid us forever. Do they ever get off the hook here?

Nexus for corporation income tax is determined on a year-to-year basis, and if a nexus activity occurs during the year, then the corporation has nexus for the entire year. For example, if on-going service and maintenance is performed by employees in Iowa, then the software developer has nexus in Iowa for that year. Also, if the service and maintenance occurred outside Iowa for a particular year, but nexus was created in that year due to installation, any income received from the on-going service and maintenance would be considered an Iowa receipt.

So if they steer clear of the land between the rivers from now on, they're off the hook. But it's not easy.

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IDED: THE MORE YOU SPEND, THE MORE YOU SAVE

June 20, 2006

Everyone has seen department store sale ads breathlessly intoning "the more you spend, the more you save!" The arithmetic seems almost plausible, until you think about it for a half-second. Then you realize the "savings" exist only if you assume away every possible use of your money other than buying things at that store.

The Iowa Department of Economic Development yesterday released a report trumpteting the successes of the Iowa Values Fund grants and incentives for small businesses. The report identifies the number of jobs "created and retained" by the IVF tax credits and incentives.

The math behind these claims is a lot like the math of the department store circular. The IDED assumes away other possible uses for the money spent on the funds. It also ignores the effects on other businesses whose competitors are subsidized by the IVF and who have to pay the higher taxes to fund it. The IDED also has no way to tell how many jobs would have been created in other ways absent the IVF funding, via banks or investors.

When all of the hidden costs are taken into account, there's no way that taxing Iowans and their businesses to lure and subsidize their competitors is a net gain to Iowa's economy.

Link: Des Moines Register Coverage

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IOWA WILL CUT YOUR HOLDING PERIODS INTO LITTLE PIECES

June 16, 2006

Iowa has an unusual tax break for capital gains on business property held for a long time. You don't have to pay Iowa taxes on certain capital gains from the sale of business assets if you have both

1. Held the property for 10 years, and
2. "materially participated" in the business for 10 years.

This week the Iowa Department of Revenue ruled that if you buy your interest in the business in pieces, your holding period is also measured in pieces, and only the pieces held for 10 years qualify for the capital gains break.

THE COLOR CONVERTING SAGA

Chandrakant Shah began working for Color Converting Industries, an S corporation, in November 1978. He first acquired an ownership interest in the business in 1983. The S corporation later contributed the assets of the business to a limited liability company, Color Converting LLC; the S corporation continued in existence as an owner of the LLC.

He acquired additional interests in 2001 by setting up a new S corporation to buy additional interests in Color Converting LLC. At this point he had interests in two S corporations owning interests in the same LLC.

When the business sold its assets in 2003, the gain was taxed on the returns of its owners, including Mr. Shah. Mr. Shah claimed the Iowa exemption for all of the capital gain passing through to his 1040 through his two S corporations. The Department disagreed:

Because Protesters seek a deduction for capital gain resulting from the sale of their entire interest in the business, and not merely a portion of the interest, the period of time that Protesters held that interest is relevant. The Department does not dispute that the portion of the sale representing Protesters interest in the business that was acquired in 1983 meets the requirements of 422.7(21). Protesters maintained an ownership interest in the business despite the fact that the business entity changed. At the time of the sale of the business, Protesters held this interest in the business for more than ten years and materially participated in the business for more than 10 years. Protesters contend however, that because the capital gain from the sale of their interest acquired in 1983 qualifies for the capital gain exclusion, that the property interest acquired in 2001 should also qualify for the exclusion.

Iowa enacted new holding period legislation this year that applies federal holding period rules to the capital gain exclusion. As federal law would treat the two interests acquired as having their own holding periods, the Iowa holding here likely would have been the same under the new law.

Link: Iowa Letter of Findings dated February 8, 2006

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LIBERAL IOWA TAX THINK TANK: MEND, DON'T END, CORPORATE TAX

May 22, 2006

Today I learned of the existence of an liberal Iowa tax policy think tank, "Iowa Fiscal Central." The organization web page says it's a collaboration between David Osterberg's Iowa Policy Project and the Child & Family Policy Center. Among their recent articles is "Revitalizing Iowa's Corporate Income Tax," which suggests ways to make Iowa's corporation tax useful. I think the idea of reviving Iowa's useless corporation tax is misguided - repeal makes more sense - but the piece makes thoughtful arguments and would probably be part of the tax policy of a Fallon governership. I plan to address the article in more detail soon.

I'm not aware of direct conservative/libertarian counterpart to Iowa Fiscal Central, though the Public Interest Institute does some work in this area. Iowans for Tax Relief is more a loophole lobby rather than a coherent tax policy shop.

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OLDSTERS THRASH WHIPPERSNAPPERS

May 03, 2006

The Iowa General Assembly scored one for age and cunning yesterday. They the old folks tax exemption that was part of last week's budget agreement between Governor Vilsack and legislative leaders. The bill passed the Senate 46-4 and the House 89-6.

Youth and ability struck out in last year's session, when a bill to exempt youth from Iowa taxes died without a floor vote.

BREAKS BEGIN TO APPLY IN 2007

The old folks bill has two parts: a large exemption for all income, and an additional exemption for social security income.

Starting in 2007, the blanket exemption excuses taxpayers who are 65 or older from income tax if their "net income" is $24,000 ($18,000 for single filers). The exemptions increase to $32,000 for married filers, surviving spouses and heads of household in 2009, and $24,000 for single filers.

"Net income" is roughly equivalent to federal adjusted gross income, except it is reduced by the the Iowa capital gain deduction, the deduction for college savings Iowa contributions, and the additional Iowa health insurance deduction.

The bill also phases out the taxation of social security retirement income in Iowa.

Current law: In computing federal taxes, 50% of social secuirty benefits are taxable if income exceeds $32,000 ($25,000 for single filers and heads of household), and 85% are taxable if income exceeds $44,000 ($32,000 for singles and households). Iowa doesn't tax the 85% portion.

New rules: Iowa will phase out its tax on social security benefits over eight years. The amount now subject to tax will be reduced by the percentages below:

          2007     32%
          2008     32%
          2009     43%
          2010     55%
          2011     67%
          2012     77%
          2013     89%
          2014    100%

TO WHAT END?

Supporters of the bill say that it will help keep retirees from leaving Iowa. Iowa's population today is the fourth-oldest in the country. By 2030, Iowa is projected to have 227,000 more people over 65 than it does now, and 246,000 fewer people between 18 and 44. Keeping old folks seems like the least of Iowa's problems.

Senator Mary Lundby says that many Iowa seniors struggle with their bills. That is certainly true. So do many younger Iowans. There are plenty of Iowans aged 18-54 who are struggling to feed their families, make mortgage or rent payments, keep the car going, pay for health insurance, and buy $2.90 gasoline. Statistically, these younger Iowans are all likely to have a lower net worth than the beneficiaries of these new tax breaks. The census bureau says that in 2000, median net worth of households under age 35 was about 6.65% of that of households 65 and up. So if you want to help struggling Iowans, a tax break based only on age is misdirected; while there are poor old Iowans, the old folks are less likely to be poor than the kids.

But we have an election coming up, and old folks tend to be reliable voters, so here we are. My hat's off to the four senators and six representatives who didn't vote to stick it to the rest of us.

Prior Coverage: GIVE US YOUR OLD, YOUR CREAKY, YOUR BINGO PLAYERS...

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GOVERNOR SIGNS HOLDING PERIOD BILL

March 31, 2006

Governor Vilsack on Wednesday signed into law the bill (H.F. 2465) on the "holding period" rules for Iowa's capital gain exclusion. The bill applies federal tax law holding period rules in determining whether property has been "held" the necessary 10 years to qualify for the Iowa capital gains breaks.

This bill overrides a risible Department of Revenue position on holding periods effective for capital gains on sales starting January 1, 2006. It's unclear whether the bill will have any effect on pending disputes with the department.

WHO QUALIFIES FOR THE EXCLUSION

The exclusion applies in several different circumstances, including:

1. Capital gains on the sale by an individual or pass-through entity of substantially all of the assets of a business held at least 10 years, if the taxpayer "materially participated" in the business for at least 10 years.

2. The sale of real estate held for at least ten years out used in a business in which the taxpayer materially participated for 10 years.

3. Gain to a shareholder on the liquidation of a corporation in which the taxpayer meets the 10-year holding and participation requirements.

"Material participation" is determined using the federal standards from the "passive activity" rules. They are summarized in the extended entry below.

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TAX FOUNDATION: IOWA NINTH WORST STATE FOR BUSINESS TAXES

February 28, 2006

The Tax Foundation has issued its annual ranking of state business tax climates (summarized here). Iowa, unsurprisingly, is one of the worst - worse even than California, if you can imagine that.

2006tfbc.JPG
Source: Tax Foundation. Click graphic for larger view.


How'd we do it?

Generally the index rewards tax codes that are neutral; that is, they have low, flat tax rates that apply to everyone. This makes tax law simpler and more transparent and avoids double taxation.

The worst state tax codes tend to have:

complex, multi-rate corporate and individual income taxes;
above-average sales tax rates that dont exempt business-to-business purchases;
complex, high-rate unemployment tax systems; and
high effective property tax rates, as well as a host of other wealth-based taxes.

Iowa leads the way to the bottom in the first category with its highest-in-the-nation 12% corporate rate. We have very complex individual and corporate systems riddled with special-interest incentives and credits. So what is the legislature doing about it? Trying to get down to number 50, as far as I can tell. Some examples:

- A bill (HF 2045) has passed the Iowa House to exempt pension and social security income from tax. This creates a favored group of taxpayers, adds complexity to the code, and requires higher rates from taxpayers outside the favored group.

- A bill (HF 2052) would allow a deduction for cars that burn E-85 fuel.

- HF 2261 would create an " Individual income tax deduction for dentists who receive state medical assistance reimbursement less than their normal fee."

- HF 2274 would provide an "Individual and corporate income tax credit for purchase and installation of methane gas conversion property by livestock producers to be used to generate electricity."

What these all have in common is that they give a small group of taxpayers a break - which means everyone not benefitting pays more. And there are lots more bills like that in the hopper. While carving up a raft of new tax breaks to buy votes, the legislature is ignoring the dire need to lower rates and get rid of the rat's nest of exemptions, credits and special favors that makes our tax law business-hostile.

Look out, No. 50 New York, we're coming at you.

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IOWA HOLDING PERIOD LEGISLATION ADVANCES

February 27, 2006

The Iowa Senate Ways and Means Committee has passed a bill (S 2093) to make Iowa's "holding period" rules the same as federal rules. The rules are used to determine whether taxpayers meet the requirements to exclude capital gains on certain property held for longer than 10 years.

The Iowa House is considering similar legislation.

While it is good that the legislature is working to override the Department of Revenue's indefensible position on this, I wish the bill explanation asserted that they think that's what the law already is - or at least that the bill shouldn't affect any current controversies before the Department.

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IOWA'S SUPER-LONG TERM CAPITAL GAINS DEDUCTION: IF YOU QUIT, DON'T WAIT TOO LONG TO RETIRE

January 31, 2006

Iowa has an unusual tax exemption for certain business capital gains. It applies if you meet two conditions:

- You "held" the property for ten years, and

- You "materially participated" in the business owning the property for 10 years.

If you miss either requirement, you lose the exemption.

For the most part, "material participation" means the same thing as it does for the federal "passivie activity" rules. This usually means 500 hours of work each year (a more complete summary is in the extended entry below).

POST-RETIREMENT PARTICIPATION

When you retire, your participation lingers under the federal rules. For most businesses, you are considered to materially participate if you have done so for five of the past ten years. This means your participation "continues" for five years after retirement. For professional service businesses, participation continues until death, even after retirement (no "of counsel" jokes allowed).

Iowa follows these rules for non-farmers. That means you have five years to sell your business property after retirement to qualify for the Iowa exclusion.

RETIRE A FARMER, DIE A FARMER

Farmers, though, get a special Iowa break. They qualify for the deduction for any property in which they materially participated for five out of eight years before "retiring" -- whatever that means. That usually works out well for farmers, because they can retire, cash rent their land, and still qualify for the deduction ten years later when they finally pack up and move to Sun City.

The key question, though, is when "retirement" occurs. A policy letter issued this month shows that the Department of Revenue doesn't necessarily equate "quitting" with "retiring." The letter has a spare fact summary:

The situation posed in your letter involves 100 acres of farmland which has been jointly owned by a husband and wife since 1974. The husband materially participated in the farming operation, and the wife actively participated with the husband in the farming operation. The husband also owned a dairy operation and used the crops from the 100 acres of farmland to help support the dairy operation. The dairy operation was liquidated in March 1993, and the 100 acres of farmland was been cash rented since 1993. The husband and wife retired and began receiving social security benefits in 1997.

The husband and wife are now planning to sell the 100 acres of farmland, and are requesting an opinion on whether the capital gain from the sale of the farmland would qualify for the capital gain deduction.

The letter ruled that the couple failed to qualify because they hadn't materially participated "the farmland" in five of the eight years before "retirement." They said retirement didn't occur until June 1997 when the couple started receiving social security benefits, and that 1992 was the last year of "material participation." since they had failed to participate in the last four-plus years before "retirement," the letter holds, they failed the "five of eight" year test.

PROBLEMS WITH THE RULING

The first problem that leaps out is technical: the statement that the couple didn't participate in the activity in 1993, the year they liquidated the herd. I believe this is exactly the type of situation that the "facts and circumstances" test of the material participation rules is meant to cover - years in which the taxpayers still were in the business, but not for long enough in the year to reach 500 hours of work. The letter anticipates it by saying the taxpayer wouldn't have qualified anyway, because the July 1997 start of Social Security benefits was more than four years after the March 1993 liquidation.

The second problem is key to the ruling: the Department considers the dairy business to be a separate business from the remaining business that apparently continued until 1997. The Department doesn't say why this is so. Did the farmers report dairy income as a separate Schedule F activity?

Finally, The regulation covering "material participation" doesn't define "retirement" anywhere. I suspect that the couple considered themselves "retired" from the dairy operation when the truck drove off with the last cow. It's unfortunate that the meaning of the key term "retirement" is left to the chance whims of the Department.

Cite: Policy Letter of January 6, 2006.

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NEW IOWA 'HOLDING PERIOD' PROPOSAL

January 27, 2006

A new bill in the Iowa Senate, SSB 3046, would require Iowa to follow federal tax rules in determining how long an asset has been "held."

This is important for taxpayers trying to qualify for the Iowa exclusion for capital gains on business property that has been "held" for at least ten years. The Department of Revenue has made up its own holding period rules based on a chain of reasoning stemming from (I'm not making this up) a misreading of an old CCH "Master Tax Guide."

The bill would apply for determining the holding period of property sold starting January 1, 2006 and retroactively to tax years ending after January 1, 2006.

There are many policy reasons against this capital gain exclusion in the first place, but if it is to exist, it should at least be easy to apply. Under the current Department of Revenue interpretation, like-kind exchanges and involuntary conversions of business property start a new holding period; under federal law, the holding period of teheexchanged property (or converted property) "tacks" to the property acquired to replace it. Taxpayers shouldn't have to deal with a separate unclear set of holding period rules based on the whim of state tax collectors.

While the proposed rules are fine as far as they go, they should be expanded to cover all open tax years. The Department's application of the rules up to now is wrong, and SSB 3046 should say so. The 2006 effective date is likely to embolden the Department to continue to defend its old holding period stance for examinations of pre-2006 tax years. At the very least, the explanation of the bill should say that the provision is a "clarification" of existing rules.

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ROTH 401(k) AND IOWA TAXES

January 19, 2006

An astute reader queries whether Roth 401(k) plan distributions will qualify for the same tax-free treatment on Iowa returns that they will have for federal purposes.

Unless the legislature does something affirmatively stupid - unlikely in this case, but never impossible - Roth 401(k) distributions will be taxed the same way on Iowa returns as on U.S. returns. Iowa annually conforms its rules for computing taxable income to the current federal rules. Unless the legislature specifies an exception, every new tax change applies to Iowa. As Iowa has not carved out Roth 401(k) distributions in it's latest code-conformity legislation, the federal rules apply to Iowa.

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THEY'RE BAA-ACK

January 11, 2006

Yes, the Iowa legislature is back in session. That means we will see any number of proposals floated to buy votes and influence by mucking up Iowa's tax law.

We'll start a new feature here where where we will try to track Iowa tax propoposals. We may not cover them all, as there are 150 legislators and one me. But here goes:

TAX-FREE GEEZER BILL

The first big income tax proposal would phase out income taxes on all pension and social security income (HSB 502). Last year they wanted to exempt young folks. Make up your minds!

This bill is pure pandering. As much as we cherish our older Iowans, they are statistically our wealthiest folks. They didn't pay taxes on their pensions while they worked, and now they aren't to pay taxes on them as retirees? Remember, giving the old folks this break by definition means a tax increase for the rest of us. The boomers are getting ready to stick it to us once again!

Or is the goal economic development: to make Iowa the next Sun City by attracting old folks here? Maybe that's what they can use that Rainforest thingy for.

In any case, the House Ways and Means Committee has already voted this thing to the floor. Bad news travels fast.

UPDATE FROM THE COMMENTS: Another tax provision to drive out those unruly youngsters.

OTHER BILLS IN BRIEF:

Exempting the sale of certain school supplies from the sales and use taxes during a specified time (HF 2001). There is no possible policy justification for a holiday. Either these things should be taxed, or not. Go here for a more detailed discussion, if you're interested.

Increasing the taxes imposed on cigarettes and tobacco products and providing for deposit of the increased revenue generated in the Senior Living Trust Fund (HF 2022). Tobacco: the revenue wonder weed. Perhaps they shouldn't raid the trust fund in the first place.

The Legislature is developing a nasty nicotine habit. All these tobacco tax increases are going to bite the legislature if people come to their senses and stop smoking. Well, they can always put cigarette vending machines next to the video lottery terminals.

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DIG IN!

June 14, 2005

Governor Vilsack signed the new Iowa Values Fund credits into law yesterday.

Pull up to the trough here. It's like ethanol at the gas station: just because they you subsidize it doesn't mean you should feel guilty for using it, if you can.

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UNLEASH THE INCENTIVE WARRIORS?

June 06, 2005

It's tax incentive day over at the TaxProf's place. The good professor links to two pieces on the debate.

David Brunori of Tax Analysts is dismayed at Congressional efforts to overturn the Cuno decision that outlawed Ohio's targeted tax credit system ("Helping States to Hurt Themselves").

The Tax Foundation Blog, on the other hand, says Cuno is bad law and should be overturned (Cuno v. DaimlerChrysler: A Pyrrhic Victory for Economic Neutrality).

I agree with the Brunori article, so we haven't a lot to add to it. The Tax Foundation piece has some thoughts we address in the extended entry below.

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DES MOINES REGISTER HIGHLIGHTS TAX INCENTIVES

June 05, 2005

From the banner article in today's edition:

Tax breaks' costs, benefits elusive

Privacy laws, array of programs complicate analysis

Iowa lawmakers keep expanding efforts to help businesses - this year rebating sales tax money to developers and adding new tax credits for job creation. But few officials, if any, can answer a basic question: How much does Iowa spend to boost its economy?

Finding the answer is key to addressing another issue: Are taxpayers getting their money's worth from the public subsidies?

The long piece by Donnelle Eller, Register Business Writer, does a good job of laying out all of the different facets of the debate over tax incentives.

TAX INCENTIVE FANS

mos1.jpgThere's the businessman who says he has to have tax breaks, or he'll go where the subsidies are greener:

Chris Nelson, president of Kemin Industries, said he receives 20 to 30 calls each week from states and countries that want him to relocate his company's operations. "The offers usually come with . . . all sorts of possible economic incentives," said Nelson, whose food-supplement company received $4.4 million in state and local incentives to build an $11 million headquarters and manufacturing expansion in Des Moines.

There's the legislator who gets lots of feedback from the happy beneficiaries, and who doesn't seem to think somebody else is paying for the benefits:

Rep. Clarence Hoffman, R-Denison, said he might have more concerns about tax credits, if he didn't see that they're creating new jobs and attracting new investment. "The rewards will be seen for years to come," he said.

There's the economic development official who justifies his salary by helping lure businesses by showing them loopholes that enable them to avoid the taxes everyone else has to pay:

Blouin said the state's economic development efforts are clearly working.

Since 2003, when the Iowa Values Fund was created, the state has awarded $77.8 million in loans and grants to 268 companies. The amount includes Iowa Values Fund money, plus loans repaid to the state and money from existing programs, said Tina Hoffman, the development agency's spokeswoman.

These happy perspectives are like looking at the health of an ecosystem based on how fat and happy the mosquitoes are. You can identify how happy the 268 beneficiaries of the fund are, but somebody else is paying for it - the thousands of other businesses that are unable to harvest any tax breaks, and who pay the costs of running the state on behalf of those who do.

The article points out how tax privacy laws make it impossible to identify who benefits from the tax breaks, or to determine what their costs and benefits really are:

Michael Ralston, director of the Iowa Department of Revenue and Finance, said he would risk going to jail if he complied with a Des Moines Sunday Register request to provide a list of companies that shared an estimated $32 million in tax breaks for research and development in 2004.

The article also quotes the Iowa Taxpayers Association, which inexplicably favors Iowa's byzantine raft of tax breaks:

The Iowa Taxpayers Association, which opposes most kinds of taxes, favors tax-supported incentives for businesses.

One reason, said Stacey Johnson, president of the group, is the high rates Iowa businesses pay. An association study showed Iowa industrial companies' tax burden ranked 12th-highest in the country . Commercial property owners' bills were third highest . Overall, Iowa businesses pay 43 percent of the total state and local taxes, she said.

Astonishing. Did it occur to Ms. Johnson that the rates are high in part because of the 20-odd incentive credits in the tax law?

THE DISSENTERS

The article notes how efforts by Rep. Pam Jochum of Dubuque to require an accounting of economic development incentives died from lack of interest. The article also mentions the Ohio court decision that threatens Iowa's tax incentives.

The article also presents views of someone who doesn't think tax incentives are a great idea:

Joe Kristan, a corporate accountant at Roth & Co. in Des Moines, suspects the tax incentives are growing because more businesses are savvier about tapping experts like him to "harvest" the tax code for breaks. Instead of encouraging new activity, the breaks likely reward businesses for current activities.

"Targeted tax credits hide the real cost of what are basically subsidies," Kristan said. "They may be for a good cause, but that doesn't mean that someone else should pay for it."

That's the scariest part of being interviewed: the likelihood of being quoted accurately, which I was.

I'm sure the Register editors thought the story was plenty long enough, but I wish they had used my little newsroom fable:

Reporter Bill goes to his editor for a raise because his car is old and he needs a new one. He has done a statistical study explaining how good it would be for the paper for him to have a car -- better stories, more circulation, and so on.

The editor feels his pain, but has no money in the budget for raises. He has an idea, though: he will reduce the state tax withholding from Reporter Bill's paycheck by enough to cover his car payments. He will make it up to the state by increasing the withholding from everyone else in the newsroom.

Just imagine how excited everyone in the newsroom will be to help Bill pay for his car - especially when the editor explains how it's for the good of the paper.

Targeted tax credits work much the same way as the Reporter Bill withholding system.

Repeat after me: With its tax incentive system, Iowa taxes its existing businesses to lure and subsidize their competitors.

Related Coverage:

WHITHER IOWA'S TAXES?

A list of Iowa's Targeted Tax Credits.

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NEW ADVENTURES IN LEGAL REASONING

May 27, 2005

Our post on "Humpty Dumpty Law at Iowa Department of Revenue and Finance" triggered an enlightening three-way correspondence among Mike Ralston, Director of the Iowa Department of Revenue and Finance; attorney George Davis, and your author.

As expected, we haven't (yet) persuaded the Director to change the Department's eccentric interpretation of the word "held." The department doesn't adopt the federal tax rules that say asset holding periods survive tax-free exchanges. We have learned more about the origin of the Department's position, though. Per Mr. Ralston:

I'm told there has been only one Iowa case litigated regarding the Iowa capital gain exclusion since the change in 1998 to remove the cap on the amount of the deduction. In James & Linda Bell, the Administrative Law Judge and the Director ruled that the reference to "held" in Iowa Code Section 422.7(21) is to ownership. To the best of my knowledge, the department has taken a consistent position that any transfer of property starts a new ten year holding period.

The Bell discussion of this issue is a jaw-dropper:

The capital gain tax laws originate with the sale of an asset. An asset cannot be sold unless it is owned. As a result, the reference to "held" is to ownership. "The holding period for a capital asset is the length of time that the taxpayer owned the property before disposing of it through sale or exchange." 2001 U.S. Master Tax Guide 1777, p.465 CCH Editorial Staff Publication. The mingling of the "material participation" with a leasehold interest is not sufficient. The clear meaning of the statute is for "held" to mean ownership. The protester does not meet the holding requirement when it is defined as ownership.

It is astounding that the Department would rely on an out-of-context quote from the "Master Tax Guide" for its position on interpreting its statute. The "Master Tax Guide" is certainly a handy reference, but it is about as authoritative as a recent Tax Update post. The reference is the classic freshman mistake of drawing a conclusion from the first paragraph read without digging further for the details

Even more astounding, as George Davis points out, is the tacit admission that they think they are relying on the federal rules for holding periods. After all, the "Master Tax Guide" is a reference to the federal tax law. If they had accurately followed through all of the references in the guide to their sources, they would have found that held doesn't equate to "owned," and that there are many instances where holding period tacks when an asset changes hands.

If the Department follows the approach of Bell, it is compelled to follow the federal holding period rules, as Bell purports to do. Of course, Bell misreads the federal rules, as an accurate reading of those rules shows that holding periods in fact do survive like-kind exchanges. If the Department corrects the Bell misreading, its position has no basis.

It remains to be seen whether the Department will relent before somebody has to take this to district court. I would love to see the look on the judge's face when the Department attorneys fall back on their "Master Tax Guide" cite.

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AGAIN THROUGH THE LOOKING GLASS: WHICH IS TO BE MASTER?

May 25, 2005

humpty_alice.jpgThe Iowa Department of Revenue explained how it figures what the tax law means in a recent protest response:

Statutes allowing exemptions from taxation are to be strictly construed with all rational doubt regarding the meaning of any words or phrases contained in them resolved against exemption and in favor of taxation.

A reader* who has some experience in this area points out a case where the Iowa Supreme Court seems to take a different view. In N. F. SORG v. IOWA DEPARTMENT OF REVENUE (no link available) the court said:

"Taxing statutes are strictly construed against the taxing body--liberally in favor of the taxpayer. It must appear from the language of the statute the tax assessed against taxpayer was clearly intended." Scott County Conservation Bd. v. Briggs, 229 N.W.2d at 127 , quoting Dodgen Industries, Inc. v. Iowa State Tax Commission, 160 N.W.2d 289 , 296 (Iowa 1968); see Iowa Movers & Warehousemen's Ass'n v. Briggs, 237 N.W.2d 759 , 769 (Iowa), cert. denied, 429 U.S. 832 , 50 L.Ed.2d 96 (1976). Construing 422.43 and the applicable definitions in 422.42 liberally in favor of Sorg and strictly against the Department, we cannot find language signaling a clear legislative intent to tax in the situation before us.
(Emphasis added.)

So which is it? In Sorg, The court says the law leans in favor of the taxpayers; the Department now says the opposite. As Humpty Dumpty told Alice, "The question is, which is to be master -- that's all."

* Thanks to reader Richard Lyford, who successfully argued Sorg at the Iowa Supreme Court.

Related Post: HUMPTY DUMPTY LAW AT IOWA DEPARTMENT OF REVENUE AND FINANCE

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STAYIN' ALIVE: DEATH COSTS SPOUSE IOWA CAPITAL GAIN EXEMPTION

May 23, 2005

The Iowa Department of Revenue wants to encourage immortality. That seems to be the message of a tax policy letter posted on the Department website this morning, anyway.

Iowa has a rule that waives taxes on the sale of some real estate used in a business and "held" for over ten years. Through its interpretation of the statute, the Department of Revenue says that held doesn't mean what it means elsewhere in the tax law. This means that if you are a farmer, maybe you'd better sell the farm before you, um, buy the farm.

In the letter issued today, a farm couple owned thier farm as tenants in common, with the husband "materially participating" in the farm operation. The husband died in December 2003, having owned the farmland for more than ten years.

The widow inherited the farm, and later sold it. The Department says that only "her" 1/2 share qualified for the capital gain exclusion; the inherited half started a new holding period.

The Department says that the tax would have been avoided if the farm had been held in a joint tenancy, rather than as tenants in common:

If the ownership had been in joint tenancy, both the husband and wife would have been deemed to own 100% of the farmland, and the wife would have been entitled to the capital gain deduction on the sale of the entire property. However, because the farmland was held as tenants in common, the capital gain deduction only applies to the original one-half interest held by the wife.

Some might say that is a picayunish distinction without a difference. While that may be true, it still behooves businsess and farm owners to carefully consider how they title their real estate if they care to use the Iowa exclusion.

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BILL SEEKS TO RETURN SHARP OBJECTS TO TODDLERS

May 19, 2005

voinovich.jpgA bipartisan group of advocates of bad tax policy led by Sen. Voinovich of Ohio yesterday announced a bill to preserve targeted state tax incentives.

Such incentives became illegal in the 6th U.S. Circuit, which includes Ohio, Michigan, Ohio and Tennessee, when the 6th Circuit Court of Appeals ruled that they violate the U.S. Constitution's commerce clause. Iowa has around 20 tax credits that likely would be struck down under the same analysis.

The 6th Circuit decision provides a golden opportunity for states to abandon their circular firing squad system of targeted incentives to bribe businesses to locate in their states. These incentives tax existing businesses to lure and subsidize their competitors, but the bribees generally have vocal and influential support. This support is evident in Tax Analysts's list of co-sponsors of the "Economic Development Act of 2005":

Seeking to protect a tax incentive program he championed as governor of Ohio, Sen. George V. Voinovich, R-Ohio, announced May 18 that he and Rep. Patrick J. Tiberi, R-Ohio, Sen. Debbie Stabenow, D- Mich., and Rep. Ben Chandler, D-Ky., would introduce legislation to overturn a recent federal appeals court decision.

...

The Senate version is being cosponsored by every senator in the Sixth Circuit, including Mike DeWine, R-Ohio; Carl Levin, D-Mich.; Lamar Alexander, R-Tenn.; Mitch McConnell, R-Ky.; Jim Bunning, R-Ky.; and Majority Leader Bill Frist, R-Tenn

Truly an impressive display of support for foolish tax policy.

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WE'RE CLUELESS. PLEASE PROVIDE ONE ON THE ATTACHED FORM

May 18, 2005

A real live letter from the Iowa Department of Revenue and Finance:

esp.JPG
(Click on letter for larger version)

Short version:

-We lost your tax returns.
-We can't find them.
-Please explain what we did with them.

We have a number of potential responses in mind - "I'll tell you where you put my return if you can tell me why she never called me back. Signed, P.P." - that sort of thing.

We invite you to suggest responses in the comments. Keep it clean!

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HUMPTY DUMPTY LAW AT IOWA DEPARTMENT OF REVENUE AND FINANCE

May 17, 2005

humpty.jpg

"When I use a word," Humpty Dumpty said in a rather scornful tone," it means just what I choose it to mean -- neither more nor less."

"The question is," said Alice, "whether you can make words mean so many things."

"The question is," said Humpty Dumpty, "which is to be master -- that's all."

                          -Alice in Wonderland


Statutes allowing exemptions from taxation are to be strictly construed with all rational doubt regarding the meaning of any words or phrases contained in them resolved against exemption and in favor of taxation

                       -Iowa Dept. of Revenue, in 
                        protest response released yesterday.

The spirit of Humpty lives on at the Iowa Department of Revenue tax policy section. Follow us through the looking glass for a peek at a protest response posted on the Department website yesterday.

Michael Fereday tried to take advantage of the Iowa "ultra-long term" capital gain deduction, which allows some taxpayers to avoid Iowa taxes on the sales of business assets or real estate held for more than 10 years. Mr. Fereday appeared to meet all of the requirements for the deduction, and his "holding period" for the property began in 1986.

But the Department can make words mean so many things -- even "held."

Because many federal tax rules - in particular, lower capital gain rates - turn on how long an asset is held, the tax law has developed a detailed set on "holding period" rules.

In 2002, Mr. Fereday sold property he had acquired in a 1997 like-kind exchange. In such exchanges, the basis and holding period of like-kind property given up carries over to the replacement property acquired in the exchange; the exchange itself isn't taxed. The property swapped away in the 1997 exchange had been acquired in 1986, giving him a 16-year holding period.

THE ROLE OF FEDERAL TAX LAW IN IOWA TAX LAW

Like most states, Iowa's tax rules piggyback the federal tax law. If they didn't do so, each state would have to re-invent the wheel; it is much easier to simply latch on to the extensive body of federal tax law that has evolved since 1913. Iowa specifically recognizes this in its "code conformity" provision for computing taxable income. The Department's own rules indicate that they will lean on federal definitions:

Federal rulings and regulations. In determining whether taxable income, net operating loss deduction or any other deductions are computed for federal tax purposes under, or have the same meaning as provided by, the Internal Revenue Code, the department will use applicable rulings and regulations that have been duly promulgated by the Commissioner of Internal Revenue, unless the director has created rules and regulations or has exercised discretionary powers as prescribed by statute which call for an alternative method for determining taxable income, net operating loss deduction, or any other deductions, or unless the department finds that an applicable Internal Revenue ruling or regulation is unauthorized according to the Iowa Code.

Yet the Department doesn't think this means "held" has the same meaning for federal purposes as it does in Iowa:

The Iowa capital gains deduction is unique to Iowa. The Internal Revenue Service does not have such a deduction. Therefore, without specific statutory authority, there is no reason to include like-kind exchange provisions in the interpretation of the Iowa statute.

WHAT PART OF 'HELD' DON'T YOU UNDERSTAND?

The Department is simply wrong. While some specifics of the Iowa capital gains deduction are indeed unique, the concept of different rates based on holding period length has been in the Code for many years.

Iowa has had no difficulty adapting federal holding period rules for other "unique" Iowa purposes. For example, Iowa has a special exclusion for farmers for sales of cattle or horses held for 24 months. The Department adopted federal holding period rules for this deduction, which has no direct federal counterpart. (Subrule 40.38(2))

If the legislature doesn't provide a specific definition of a word when it passes a tax law, the sound and sensible assumption is that it means the same thing that it means elsewhere in the tax law.

Yet, incredibly, the Department says that unless the legislature provides a definition for every term in a statute, the Department gets to make one up. In fact, they say, they must do so, and in the most taxpayer-hostile manner possible.

LET'S MAKE THIS HARD

This exclusion is itself an item of complexity created by the legislature. Rather than having low rates on a broad base, Iowa has high rates and lots of narrowly-focused exclusions. Not to be outdone, the Department has made it more narrow and more complicated.

The Department's approach illustrates why states normally piggyback on federal law. Without federal tax rules to guide them, Iowa taxpayers have to guess whether an otherwise sensible transaction causes an Iowa problem. The Department has never provided comprehensive guidance as to its own holding period rules here, so taxpayers have to guess what the Department will do, or seek transaction by transaction guidance -- an expensive and slow process. If the Department instead simply adopted the federal definitions, taxpayers would be able to know where they stand.

Of course, we charge by the hour, so maybe we should just shut up. Useless busy work for tax practitioners - Iowa's path to progress!

(Thanks for George Davis for the tip).

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ARE IOWA VALUES FUND TAX CREDITS UNCONSTITUTIONAL?

May 03, 2005

The new Grow Iowa Values Fund legislation (H.F. 868) headed to the Governor's desk relies heavily on new and improved targeted tax credits to launch the Iowa economy into the 21st century. Yes, we know, it's a little late, but better late than never.

The reliance on these credits isn't surprising; targeted tax credits have been at the core of Iowa's economic development efforts for years. While they haven't made Iowa an economic juggernaut, the 19 existing credits have their grateful and vocal constituencies.

But what if they are illegal?

A COMMERCE CLAUSE VIOLATION?

The U.S. Court of Appeals for the Sixth Circuit has ruled that Ohio's investment tax credit scheme is unconstitutional as a violation of the commerce clause (Cuno v. Daimler-Chrysler, Inc):

Specifically, any corporation currently doing business in Ohio, and therefore paying the state's corporate franchise tax in Ohio, can reduce its existing tax liability by locating significant new machinery and equipment within the state, but it will receive no such reduction in tax liability if it locates a comparable plant and equipment elsewhere. Moreover, as between two businesses, otherwise similarly situated and each subject to Ohio taxation, the business that chooses to expand its local presence will enjoy a reduced tax burden, based directly on its new in-state investment, while a competitor that invests out-of-state will face a comparatively higher tax burden because it will be ineligible for any credit against its Ohio tax.
(emphasis added)

This ruling, if its application expands to our Eighth Circuit, would likely invalidate the tax credits in H.F. 868; indeed, it would undo almost all of Iowa's 19 existing credits. An excellent writeup in yesterday's State Tax Notes (available to all today thanks to the invaluable efforts of the TaxProf) outlines how the ruling's logic threatens similar credits in other states:

If Cuno is expanded nationally or its rationale is accepted by a Minnesota court, it is very likely the Minnesota statutes at issue in Olson would be struck down, as they are very similar to the Ohio statutes. The most obvious similarity is that both programs provide credits against corporate franchise tax for investments and purchases made within Ohio or within specific designated areas in Minnesota. In both states, the investments must represent increased economic activity. In Minnesota, businesses qualifying for the credits must increase their employment or capital investment by a set percentage. Under the invalidated Ohio statutes, businesses receive credits depending on how much their individual investment compares with overall new investments within a county.

The paragraph would be just as accurate if you substitute "Iowa" for "Minnesota." In fact, cases challenging targeted credits have been filed in Minnesota and Nebraska, both of which are in the same circuit as Iowa.

The authors of the Tax Analysts article expect the Supreme Court to decide the issue. Unless they reverse the Sixth Circuit, all of the legislature's economic development efforts may be worthless. <insert your own smart-alec comment here>

IS THERE ANOTHER WAY?

Sometimes it's said that politicians will do the right thing, after all alternatives have been exhausted. The courts might get Iowa to consider whether a low-rate, simple tax system with a broad base might be more attractive to businesses than our byzantine system with all of its credits and incentives.

The current system taxes Iowa's existing businesses to lure and subsidize their competitors. It's sort of like trying to attract girls by beating your wife. And anyone you attract that way probably isn't much of a catch.

UPDATE: Chad makes a good point down in the comments:

I've been thinking about this and wonder whether these tax credits/corporate welfare subsidies violate the Iowa Constitution's equal protection clause in the same way differential tax rates on land based and water based casinos do. Certainly the Newton racetrack sales tax giveaway seems spot on for violation.

We've had similar thoughts.

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TAX CREDITS! THAT'S THE ANSWER!

April 28, 2005

The Iowa House last night passed a new incarnation of the "Grow Iowa Values" fund. The bill (H.F. 868) features - sit down - new targeted tax credits! And it modifies some we already have! As Iowa only has 19 or so targeted tax credits now, these are no doubt badly needed. The new credits include:

-Economic Development Region Revolving Fund Tax Credit. This credit will equal 20% of the contribution made to an "economic development region revolving fund." It appears these will fund "economic development initiatives that are either unique to the region or innovative in design and implementation."

- We get a "Historic Preservation and Cultural and Entertainment District Tax Credit." This replaces and expands the existing Property Rehabilitation credit.

- The bill tweaks the existing "Investment Tax Credit" for "eligible businesses" meeting a ridiculously long list of criteria for projects that have won the approval of local politicians communities. The list of criteria is in the extended entry section for your convenience; click "read more" at the bottom of this post. Note that this specifically excludes retail and service businesses. Those "new economy" jobs aren't real jobs, anyway.

- The bill adds a New Jobs Credit From Withholding. This credit, which only applies to "eligible busineses," is similar to the existing new jobs credit for jobs under community college agreements, but it applies at a rate 1/2 percent of gross wages paid, without the caps of the existing programs. It applies on top of the existing credit.

-We also get an all new "Wage Benefits Tax Credit." This is available businesses (not just "eligible businesses") who add jobs with wages exceeding 130 percent of the average county wage, and who have their application for the credit certified by the Department of Economic Development. This also applies only to "non-retail, non-service" businesses. Take that, new economy!

-The existing Research and Development Credit is tweaked to allow up to $1 million in tax credits for "development and deployment of innovative renewable energy generation components manufactured or assembled in this state."

WINNERS AND LOSERS

If you are an industrial policy fan, believing that the state legislature and Iowa's Department of Economic Development can spur economic growth through judicious evaluation of businesses and distribution of carefully-targeted tax breaks, this bill is for you.

If you think that the last thing Iowa needs is more byzantine tax credits and more involvement of politicians and bureaucrats in determining the future of the economy, well, maybe next year.

If you charge by the hour to help businesses take advantage of tax credits, like we do, this truly is economic development. Party on.

UPDATE: State 29 is all over this like a cheap suit; he also has a link to the 92-8 roll call. The eight "nays":

Baudler (R, Adair Co.); De Boef (R, Keokuk Co.); Eichorn (R, Hamilton Co.); Fallon (D, Polk Co.); Jochum (D, Dubuque Co.); Sands (R, Louisa Co.); Scoultz (D, Black Hawk Co.); Van Engelenhoven (R, Marion Co.)

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LET'S GIVE THESE FOLKS A TAX BREAK

April 19, 2005

We're overdue in noting this, but State 29 has read the Des Moines Register writeup on the questionable nature of the financiers behind the proposed Newton Speedway and done some homework of his own.

This is the project that is targeted for a unique tax break - letting it keep the sales tax it collects.

Thanks to Random for the reminder.

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IOWA DEPARTMENT OF REVENUE GETS IT WRONG AGAIN

April 11, 2005

Pass-through entities - S corporations, LLCs and other partnership vehicles - have become increasingly popular in the tax world. The income of these entities is taxed on their owners returns, avoiding an additional layer of corporate tax. Now Iowa wants to add it's own second layer of tax for many pass-throughs.

One drawback of these entities is that when the entity files in many states, the individual owner is also taxed in those states. This can result in dozens of state tax returns for each owner. Most states alleviate this problem by permitting "composite" returns, allowing the corporation to file a group 1040 on behalf of non-resident shareholders.

All states that impose an income tax allow a credit for taxes paid to other states to prevent the doubling-up of state taxes. In general, if you pay a tax to a non-resident state, you reduce your resident tax by the the non-resident state tax (but by no more than the home state tax computed on the income taxed by the other state).

Today the Iowa Department of Revenue issued a "policy letter" saying that taxes paid on composite returns don't qualify as taxes for the non-resident credit. In a crabbed and shortsighted interpretation, the Department said that because the tax is paid "on behalf" of a taxpayer on a composite return, rather than "by" the taxpayer, it doesn't qualify for the credit.

This is silly. Many states require corporations to "withhold" tax on non-resident pass-through owners. Is Iowa next going to say this doesn't qualify because it's not paid "by" the shareholder?

Under this policy, the department forces pass-through owners to choose between paying perhaps thousands of dollars to file in multiple states, or allowing Iowa to subject their income to an unauthorized second state tax.

That will do a lot for economic development.

Belated thanks to ever-alert George Davis for the tip.

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SENATE PASSES IOWA-FEDERAL TAX CODE CONFORMITY

April 06, 2005

The Senate yesterday passed HF 186, the bill to bring Iowa's tax law into conformity with the federal changes passed in the last year, including the 2004 deduction for 2005 Tsunami relief contributions. It passed 50-0, so the Governor's approval may be assumed.

The House passed the bill in February. It appears that the Senate passed an identical version.

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WE DON'T LIKE SURPRISES

March 29, 2005

As we are about to enter the final month of tax season, hundreds of thousands of Iowa returns have already been filed. Many of these returns are computed assuming that the Iowa General Assembly will pass HF 721, which would bring Iowa tax law up to date with the federal changes enacted in the last year.

Like a second marriage, this faith in the responsibility of our legislature is a triumph of hope over experience. Yet we take a number of deductions, such as the January Tsunami contribution deduction, based on this faith.

The Senate has been sitting on HF 721 since February 17. There's no indication that it is controversial, and we expect it to pass.

Yet... the legislature has surprised us before. Let's hope they don't surprise again.

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VAN FOSSEN TO TAKE UP 'BORDER TOWN' EXEMPTION

March 18, 2005

vanfossen.jpgTax Analysts reports that Jamie Van Fossen, chair of the Iowa House Ways and Means Committee, plans to take up the bill to allow Iowa's border cities to opt out of some or all of the state income tax. The bill, HF 721, would require the towns to make up the revenues with other tax increases.

This would mean every little border town might have a different income tax, sales tax, and property tax system. The state would have to figure out where in the state people live to determine whether the returns are even prepared correctly. This is a terrible idea. It also may be unconstitutional, though heaven only knows what that means in Iowa anymore.

In contrast, there appear to be no plans to take up SF 158, which actually deals with the structural problems of Iowa's byzantine tax system.

Fortunately, HF 721 appears to be veto bait if it is ever passed.

UPDATE: This bill has State 29 thinking outside the box.

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IOWA LEGISLATURE TAX BILL UPDATE

March 11, 2005

This was "funnel week" at the Iowa legislature. All bills that have failed to pass out of either a House or Senate committee are dead for the session.

Bills that remain alive include:

HF 186. This bill is the most important bill for this tax season, as it is the bill that would bring the Iowa rules for 2004 in line with federal rules. Two items that are affected are the 2004 deduction for Tsunami relief contributions made in January 2005 and the optional deduction for sales taxes. This bill passed the house February 15 and has been languishing in the Senate Ways and Means Committee. It's not like people need to know what the law is for 2004 to file their 2004 returns or anything.

HSB 139 passed the Iowa House Economic Growth Committee, 17-9. This misbegotten bill would allow Iowa cities within 5 miles of the state line opt out of the state income tax. It's a silly idea, but since we charge by the hour, we should probably support anything that makes the tax law more complicated and expensive to comply with. If this passes, we can expect cities like Atlantic and Cherokee to want to opt out of the income tax so they can compete with border towns like Council Bluffs and Sioux City.

DEAD BILLS

SF 158, a bill to completely redo and rationalize the state's tax system, failed to move. It would resolve the problems of border counties (and all of the others) by actually simplifying the system and lowering rates. That's sensible, so it probably was doomed from the start.

SF 132 also died. This was perhaps our favorite bill, as it would have given artists a credit against state income taxes for charitable contributions of their own artwork. If it ever does pass, we have made plans to open an internet art museum to accept contributions of valuable digital works of art. Our museum would enable worthy digital artists to get away with murder well-earned state tax credits for contributions of work like this artfully-composed and incredibly expressive digital photograph:

tacks.jpg
Tacks Shelter, Volume 2. Copyright Joe Kristan, All Tax Credits Reserved

PS: Sorry, Brett.

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WHAT, ME HURRY? II

March 07, 2005

Like sand through the hourglass, so pass the days of our tax season.

Meanwhile, the Iowa Senate Ways and Means Committee has been sitting for three weeks on a key bill that affects the tax returns now being filed for 2004. The House passed HF 186, the bill to make bring Iowa's tax laws up to date with the federal tax rules, on February 17.

Until this passes, Iowans can't be certain that their Iowa tax returns will be in compliance with the tax law for 2004. Considering what a hash the legislature made for 2003 by changing the 2003 rules in September, 2004, we'd feel better if they'd take care of this quickly.

What's the holdup?

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SENATE PASSES DEPRECIATION CATCH-UP

February 17, 2005

The Iowa Senate passes HF 102! 49-1. Now it's up to the Governor.

UPDATE: The Legislature's web site now shows the vote has 49-0.

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TSUNAMI, SALES TAX DEDUCTIONS ADVANCE AT STATEHOUSE

February 16, 2005

The Iowa House has passed a "code conformity" bill (HF 186) that would give Iowans the ability to deduct January 2005 Tsunami relief contributons on their 2004 Iowa returns. This would allow Iowans to take the same Tsumani deductions on both their federal and Iowa income tax returns.

The bill also gives Iowans the ability to deduct sales taxes in lieu of state income taxes on their state tax returns. This deduction would only be available if you also used the sales tax deduction on your federal returns.

The Senate has already passed a version of Tsunami relief, and this bill is expected to be noncontroversial, when they get around to it.

The depreciation catch-up bill still awaits action.

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IOWA BONUS DEPRECIATION CATCH-UP CLEARS HOUSE

January 26, 2005

The Iowa House yesterday passed HF 102 (formerly HF 23). The bill is an effort to clean up the depreciation and Section 179 mess left at the end of last year's special session.

The new bill would permit taxpayers to claim on 2004 returns the extra 2003 bonus depreciation and Section 179 deduction allowed in the Legislature's September 2004 special session. It would also allow taxpayers to simply continue to use the depreciation rules that were in effect before the special session.

The 2004 special session allowed Iowa taxpayers to claim bonus depreciation for assets eligible for federal 50% bonus depreciation. It also increased the Iowa maximum Section 179 deduction to $100,000 (from $25,000) to match the federal maximum. These changes were effective for 2003 returns, but were not passed until after most 2003 returns had been filed. The Department of Revenue then announced that the only way to use the deduction would be to file amended returns.

A Senate version of the bill (SSB 1061) was referred today to the Senate Ways and Means Committee.

WHAT WILL THE GOVERNOR DO?

The bill passed the house 99-0. No opposition has yet been noted, but the Governor's office has not committed to sign the bill. An aide to the Governor's office said, "Before the Governor can take a position, we like to see the bill in final form. The Senate has been known to frequently change and amend House Files."

Given the 99-0 margin in the house, it seems that the bill is an unlikely veto target.

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WILL IOWA ALLOW 2003 BONUS DEPRECIATION ON 2004 RETURNS?

January 13, 2005

dcarroll.jpgDanny Carroll (R-Grinnell), Iowa House Speaker Pro Tempore, has introduced a bill (HF 23) to allow Iowans to take their 2003 "bonus" depreciation on 2004 returns. The bill would also allow taxpayers to "catch up" their 2003 Iowa Section 179 deductions on 2004 returns.

Legislation enacted last September allows Iowans to take "bonus" depreciation on assets placed in service after May 5, 2003; the legislation also conformed the limit for Iowa Section 179 deduction to the federal level of $100,000 for 2003. Of course, most Iowans had already filed their 2003 returns by the time this law was enacted.

The Department of Revenue has taken the misguided position that the only way for Iowans to take advantage of the law change is to amend their 2003 returns. It would be much more reasonable to permit Iowans to "catch up" the depreciation on 2004 returns, eliminating the need to pay preparers to amend returns. The cost of amending returns effectively denies the advantage of the deduction to many Iowans.

The bill to do legislatively what the Department refuses to do administratively is co-sponsored by Linn County Democrat Rob Hogg, so it doesn't appear to be a partisan issue. With Rep. Carroll pushing the bill, we can hope it will move quickly; otherwise it will be too late in the filing season to be of much use. No Senate counterpart of the bill has yet been introduced, as far as we can tell.

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