When the Tax Cuts and Jobs Act was passed in 2017, concerns over the impact to taxpayers led some states to decouple, or choose not to follow, certain aspects of the new federal tax law.
“Each state, depending on how their tax laws were structured, either ended up with huge amounts of money projected coming in and their residents could have been adversely affected,” says John Lieberman, a certified public accountant in New York City.
“This is an unusual country in the sense that we have a federal law and we have a federal tax collection agency, and in addition there are over 3,000 taxing entities in the United States,” he says. “In other countries, there's only one tax authority and tax code that people deal with and they don't have state or provincial taxes.”
This means states could choose how to follow and interpret the tax law to their benefit by ignoring the new law or making changes to their own laws, Lieberman says.
“Five states went out and cut their state tax rates, they made certain changes for economic incentives—they did their own tax reform, taking into consideration what would be best for the citizens of their state,” Lieberman says.
California, Texas, Minnesota, North Carolina, South Carolina, and New Hampshire did not conform to the new law but rather changed their own laws to be more favorable to residents. For example, they have not enacted legislation to revise their conformity dates for when they will have to abide by the new federal tax reform, so previous tax laws are still in affect.
New Hampshire increased its business equipment deduction limit from $100,000 to $500,000, which matches last year’s federal limit, as opposed to the current federal limit of $1 million. This causes a lower tax benefit to businesses.
"Small businesses may end up paying more in taxes due to state decoupling,” says Ebong Eka, a certified public accountant with Ericorp Consulting. “The states may miss out on additional tax revenues by following federal law.”
Eka says many states disallow bonus depreciation, which is an additional depreciation deduction on property or equipment, even though the IRS allows it on a tax return. “This boosts the tax revenue for the state and costs the small business more money due to a disallowed deduction," he says.
Lieberman says New York decoupled completely and decided to follow federal tax law from 2017 instead of changing its tax law. This benefits residents because if federal rules were followed, residents would be taxed on a higher taxable income under the newer rules. Decoupling created a “more level playing field,” Lieberman says. In New York, this means taxpayers can still itemize deductions on their state tax returns that they aren’t allowed to claim on federal their tax returns, such as real estate taxes without limit and unreimbursed business expenses.
Lieberman says in using tax software, state codes have been added to incorporate the changes and calculate properly, but often the software is being rewritten as the filing season continues, or more guidance is needed to figure out what Congress actually wanted, causing more headaches for accountants and taxpayers.
“The IRS approves how to figure it out, but remember that the IRS was shut down during a critical time period,” Lieberman says. “This new tax code was written very quickly and there's little and large gaps so we're not sure how to interpret so we’re still waiting for some guidance from the IRS.”