How the Tax Cut Bill Is Raising Your State Taxes

Federal Income Taxes, Local Taxes, State Taxes, Tax Returns, Taxes

What goes up must come down – when considering the effects of gravity. That principle doesn’t typically apply to taxes. In the rare cases where taxes do go down, other taxes tend to go up to compensate government coffers.

Because state taxes are often linked to the federal tax code in different ways, changes in the federal tax law have ripple effects that are felt throughout the states. Due to its broad scope, the recently enacted Tax Cuts and Jobs Act (TCJA) will highlight these linkages in ways not seen in years – and your tax bill may increase as a result.

Most states link their state income tax code to the federal code as a matter of convenience. Nine states have no income tax at all, and four others make their calculations independent of federal policy. The rest conform on either a static basis – adopting the code as of a given date, such as January 1, 2018 – or a rolling basis, meaning that federal changes are automatically incorporated into the state code.

States may incorporate federal changes in deductions, exemptions, credits, and the definition of taxable income, but they keep their tax rates separate. Generally, the TCJA is a tradeoff of lower tax rates in exchange for limits on deductions/credits and a general disincentive to itemize. TCJA limitations pass on to states, but lower tax rates do not.

Unless affected states take their own steps to lower their tax rates, state tax revenues will generally rise as a result. The effect on you depends on how much you make, where you live, and your general tax status – do you itemize, and if so, what deductions do you take?

Effects are not even throughout the states due to differences in definitions of taxable income, which income adjustments are allowed, and which deductions, exemptions, and tax credits still apply. A 2016 study from the Pew Charitable Trusts details the various aspects of state-federal tax linkage.

The Pew study is outdated, but it accurately represents the complicated and uneven ways in which state and federal taxes are intertwined. Even though tax reform was pitched as simplification, it’s a safe bet that the federal and state tax relationship is as complicated as ever (and is arguably worse than it was).

You may see a further increase in your state taxes thanks to the TCJA’s change in the state and local tax (SALT) deduction. The federal SALT deduction is now capped at $10,000 on collective state and local taxes, including income/sales and property taxes. Residents of states with high taxes and/or high property values may lose valuable itemized deductions.

On average, the TCJA is expected to reduce federal taxes, but that effect varies by state. If your state income tax increases greatly because of the linkage between federal and state codes and you itemize in a high-tax/high-property value state, you may have lost the ability to recoup some of your state tax increases via lowering your federal tax bill.

Remember that governments rarely, if ever, enact tax cuts, assuming that overall government income will decrease as a result. You may well come out ahead in any particular tax cut – but be sure to look at the bigger picture, including the effect on your state taxes, before you celebrate.

Do a full check of your finances and upcoming taxes before you blow your anticipated tax savings on a big-screen TV or the latest iPhone. You may not see the savings that you expected.

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