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Montana Adopts Individual and Corporate Income Tax Reform

5 min readBy: Maxwell James, Jared Walczak

Montana adopted structural reforms to both individual and corporate income taxes during the recently adjourned legislative session, enacting three bills reducing individual taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rates, simplifying the state’s individual tax system, repealing 16 tax credits, and changing the apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. factor for corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. . This tax reform package, signed by Gov. Greg Gianforte (R) in early May, comes about six years after a similar set of bills was vetoed by a prior governor in 2015.

Senate Bill 159 reduces the top marginal income tax rate from 6.9 to 6.75 percent while keeping the existing seven-bracket system otherwise unchanged. Although the rate reduction is limited to the top marginal rate, it benefits most taxpayers, as the top bracket starts at $18,700 for both individual and joint filers, while median household income in the state is $57,153. The rate reduction goes into effect in 2022, while the bill’s provisions expire after 2024, a sunset provision which was contingent on enactment of S.B. 399.

Senate Bill 399 makes sweeping structural changes to the state’s individual income tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. s and tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s offered, and generally brings the state’s tax code into greater conformity with the Internal Revenue Code.

The biggest change the bill makes to the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. system is scrapping the seven-bracket system and implementing a streamlined two-bracket system with rates of 4.7 and 6.5 percent, with bracket widths that are doubled for joint filers, avoiding the marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. that currently exists in the state’s income tax. As part of this simplification, the state will adopt federal taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. as the starting point for determining Montana taxable income, automatically incorporating the federal standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. .

Although the lowest rate rises to 4.7 percent, up from 1.0 percent, conforming to the federal standard deduction ($12,400 last year, compared to Montana’s current standard deduction of $4,790) yields tax savings for low-income taxpayers as well. For instance, a taxpayer making $20,500 a year—the point at which the new second bracket would kick in—would have paid $783 in taxes last year under the current system, but only $381 under S.B. 399 had it been in effect that year. Savings would be magnified for dual earning families since the legislation also eliminates the state’s marriage penalty.

Current Tax Code Under S.B. 399
1.0% > $0 4.7% > $0
2.0% > $3,100 6.5% > $20,500
3.0% > $5,000
4.0% > $8,400
5.0% > $11,300
6.0% > $14,500
6.9% > $18,700

Sources: S.B. 399; Tax Foundation.

Senate Bill 399 also repeals 16 income tax credits affecting both individual and corporate taxpayers ranging from the alternative fuel tax credit to the adoption tax credit, indicating a move away from a more complex system to a simpler one featuring lower rates. The bill, however, does not eliminate the carryforward of the credits accumulated up to January 1, 2022, allowing taxpayers to use them to offset income until they have been completely expended. The new law provides greater simplicity and neutrality, trading targeted incentives for lower rates.

Tax Credits Repealed by S.B. 399
·College Contribution Credit ·Alternative Energy Credit
·Energy Conservation Credit ·Low-emissions Wood or Biomass Credit
·Alternative Fuel Credit ·Alternative Energy Production Credit
·Health Insurance for Uninsured MT Credit ·Mineral/Coal Exploration Credit
·Elderly Care Credit ·Emergency Lodging Credit
·Dependent Care Credit ·Empowerment Zone Credit
·Biodiesel Blending and Storage Credit ·Adoption Credit
·Geothermal Systems Credit ·Oil Seed Credit

Source: Montana S.B. 399 bill text; Montana S.B. 339 Budget Director’s Report.

Senate Bill 399’s provisions do not all kick in at once. Rather, the 16 credits are repealed effective tax year 2022, while the rest of the changes are not effective until 2024 tax year, after the provisions of S.B. 399 sunset.

Finally, Senate Bill 376 replaces the state’s equally weighted three-factor apportionment formula for corporate income tax with a double-weighted sales factor apportionment formula, following a trend of states weighting sales more heavily for apportionment purposes. (Many have moved to single sales factor, although Montana still retains the traditional payroll and property factors, albeit with reduced weighting.)

Changing the weight of the sales factor for apportionment reduces the tax burden for firms which have most of their property and payroll in the state while only having a small portion of their national sales in the state. Conversely, firms with only a modest presence in the state—or, for sellers of services, purely economic nexus–but a large proportion of sales sourced to the state will see their tax liability increase.

Taken together, these three bills represent a transition to a simpler, more pro-growth tax regime. The combined annual revenue loss will be about $60 million, about 1 percent of the state budget and about 2.3 percent of general fund revenues. The state’s general fund revenues grew modestly in FY 2020 despite the pandemic and is running substantially higher in FY 2021 with forecasts showing additional growth in subsequent years, which should provide fiscal space for these tax cuts to be implemented out of revenue growth.

This is important because the American Rescue Plan Act prohibits Fiscal Recovery Funds—Montana is receiving $906 million at the state level—from being used to facilitate net tax cuts, either directly or indirectly, but the U.S. Department of the Treasury has made clear that states are still free to cut taxes out of their own revenue growth without fear that any Recovery Funds would be recouped.

Montana’s tax reform package seeks to capitalize on an era of remote work, attracting taxpayers fleeing higher tax jurisdictions. Policymakers in Idaho and Oklahoma have done likewise, with significant tax relief also being considered in North Carolina, Louisiana, and elsewhere.

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