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Daily Tax Report: State

Midwest States Take a Pass on SALT Cap Workaround Laws

Sept. 16, 2019, 8:46 AM

Escalating tensions between coastal states and the federal government about circumventing the $10,000 cap on state and local tax deductions have so far drawn a big yawn from states in the middle of the country.

High-tax Midwestern states such as Illinois, Iowa, Minnesota, and Wisconsin have essentially ignored the warfare between the Treasury Department and coastal states—including California, Connecticut, New Jersey, and New York—which enacted strategies designed to ease the pain of the 2017 tax law’s SALT limit.

In June the Treasury Department targeted (T.D. 9864) a strategy that would allow taxpayers to donate to state-sponsored charitable funds in exchange for a tax credit. Connecticut, New Jersey and New York filed suit against the government a month later.

Various workaround schemes were proposed in Midwestern capitols at the beginning of 2018, but the bills got little traction and were largely dropped during the 2019 legislative session. With other state and local tax problems to conquer, Midwestern policymakers are satisfied to let their friends on the coasts fight the workaround war.

“I don’t think it will resurface, unless California, New York and Connecticut and the other states are successful,” said Carol Portman,president of the Taxpayers Federation of Illinois. “Let those guys be the canaries in the coal mine.”

Minnesota lawmakers have adopted a similar position.

“I suspect some are saying ‘Let’s see what flies and act accordingly,’ ” said Mark Haveman, executive director of the Minnesota Center for Fiscal Excellence.

High State and Local Tax Burdens

Some corn- and rust-belt states would seem likely combatants in any debate over the $10,000 SALT cap limitation. Iowa, Minnesota, and Wisconsin are generally regarded as high income tax states. Illinois, Michigan and Wisconsin have reputations for imposing high property taxes.

A tax burden comparison by the Tax Foundation showed Midwestern states run neck and neck with high-tax jurisdictions on the coasts. New York, Connecticut, and New Jersey held the first, second and third spots with residents respectively paying 12.7 %, 12.6%, and 12.2% of their total incomes to cover state and local tax obligations. California ranked sixth.

The same comparison showed Wisconsin ranked fourth and Illinois ranked fifth. Residents of both states paid 11% of their incomes in state and local taxes. Minnesota ranked eighth at 10.8%.

In Illinois a workaround bill failed during the 2018 legislative session, but the state seemed fertile ground for a second legislative push with the arrival of a Democratic governor and a Democratic Legislature the following year.

Workaround legislation, however, was shoved to the side as lawmakers embarked on an ambitious tax agenda aimed at raising revenue and improving the state’s fiscal condition. The progressive tax agenda included a plan that could replace Illinois’ constitutionally required flat income tax with a graduated system. Illinois voters will be asked to amend the state constitution during the 2020 general election.

The workaround idea also lost some momentum as some progressives began to view it as a strategy benefiting wealthy property owners.

“In a state like ours, going to great lengths to help the high income folks reduce the amount of tax they’ve paid isn’t unusually high on the progressive agenda,” Portman said.

‘Consumed With Conformity’

Similarly, the Minnesota Legislature was too busy writing a two-year budget and crafting legislation to align the state’s tax law’s with those from the 2017 law to pay attention to workaround legislation.

“We were so consumed with conformity and a biennial budget this session, it sucked all the oxygen out of the tax committees,” Haveman said.

While Iowans are saddled with high income tax rates and relatively high property taxes, Iowa taxpayers and the state’s Republican-led Legislature were generally satisfied with the higher standard deduction and the lower rates embedded in the tax law.

“Even though we are a high marginal tax rate state, our property taxes—while high in our minds—tend to be lower,” said Tom Sands, president of the Iowa Taxpayers Association. “So we wouldn’t have that many people that get tapped out. And the ones that do are getting enough benefits under the lower business tax rate or the individual rate such that this would not be their biggest concern.”

Action on Pass-Throughs

Wisconsin and Michigan have been workaround outliers in the Midwest, focusing on legislation addressing workarounds for pass-through entities.

At the end of 2018, former Gov. Scott Walker (R) signed Wisconsin Act 368, which permits S corporations, partnerships and limited liability companies to elect to be taxed at the entity level rather than the individual level under Wisconsin’s income tax.

Taxpayers making this election are taxed at the corporate income tax rate of 7.9% rather than the individual rate, which ranges as high as 7.65%. This is seen as a narrow change, benefiting a limited number of individual owners, who are permitted a subtraction from Wisconsin adjusted gross income for their share of income or gain from the pass-through.

Michigan has had a more complicated relationship with two pass-through bills. One workaround bill was vetoed and another has been tied-up in budget negotiations.

Last year Michigan’s business community cheered when the GOP-controlled legislature passed a workaround billsimilar to the law enacted in Wisconsin. That proposal could have saved Michigan businesses $190 million off their annual federal income taxes, but former Gov. Rick Snyder (R) vetoed the proposal out of concerns the IRS might short-circuit the proposed law.

This year the idea resurfaced in Gov. Gretchen Whitmer’s (D) budget proposal, but her plan would require pass-through entities to pay the state’s flat 6% corporate income tax instead of allowing owners to pay the 4.25% individual income tax on corporate earnings. She estimated this switch would boost tax revenue by $217 million in 2021.

But those budget negotiations are on the skids thanks to a battle over how to pay for the state’s estimated $2.5 billion in additional infrastructure needs. That has left the Michigan business community stuck between advocating for investment in transportation, but not wanting to raise the profile of a corporate tax increase as a possibility.

“If they were to pass a 45-cent gas tax tomorrow, and the budget gets signed and we have revenue for roads, maybe next year we could take a stab at it,” said Dan Papineau, director of Tax Policy & Regulatory Affairs with the Michigan Chamber of Commerce. “But addressing it now it would make us a target.”

Congress’s Role

The calculus for Midwestern states could change depending on what happens in Congress. Democratic lawmakers there have slammed the cap since the tax law was enacted, but they face major challenges to making any changes. Republicans are unwilling to adjust the limit, and doing so could be seen as giving the rich a tax break.

The House Ways and Means Committee’s SALT working group is working on a bill that would address the cap, although they are still debating components.

Illinois Democrats are among those at the front of the congressional debate.

Illinois Democratic representatives Lauren Underwood and Sean Casten have a bill (H.R. 1757) that would increase the cap to $15,000 for individuals and $30,000 for couples.

Over the summer Democratic senators Tammy Duckworth and Dick Durbin signed on to a joint resolution, S.J. Res. 50, that would overturn the Treasury Department’s rule prohibiting state workarounds. The House version, H.J. Res. 72, has five Illinois Democrats as cosponsors.

Peter Roskam, a former Illinois Republican on Ways and Means who was an architect of the tax law, predicted the Democratic strategies would go nowhere for the foreseeable future.

“The leadership has to make a calculus, do they want to put this on the floor and have their members vote for it with the near certainty that it’s not going to move anywhere in the U.S. Senate,” said Roskam, a partner at Sidley Austin LLP. “So why would you want to put someone on a roll call that gives a tax break to wealthier people if you know it’s never going to become the law?”

—With assistance from Alex Ebert in Columbus, Ohio.

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bloomberglaw.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com