Missouri Governor Set to Sign Income Tax Cuts

July 11, 2018

On Thursday, Missouri Governor Mike Parson (R) is set to sign House Bill 2540, which cuts the top rate of the individual income tax from 5.9 to 5.5 percent next year, while continuing with triggered reductions that could potentially bring the top rate to 5.1 percent.

Federal tax reform changed the landscape in the states. Most states captured at least some of the federal law’s base broadening, while the corresponding rate reductions do not flow through to states. Consequently, most states could expect additional revenue. Missouri’s situation turned out to be one of the more complex.

The state’s standard deduction conforms to the federal standard deduction, which nearly doubled under the new law—a substantial savings for taxpayers. Its personal exemption, however, was $2,100 for each exemption a taxpayer is entitled to take at the federal level. The new law wiped out personal exemptions, but it did so by setting their value to $0 (resulting in them being taken off the tax form), not by repealing them outright. Is a taxpayer entitled to take the federal personal exemption if it still theoretically exists, but cannot be claimed?

Statutory language in most other states didn’t create such interpretive difficulties. The most straightforward reading of the Missouri statute is that the state’s personal exemption is eliminated, the interpretation ultimately adopted by the Department of Revenue. So taxpayers were getting a tax break with the higher standard deduction, but losing some of it to the eliminated personal exemption.

While many other states were content to keep revenue windfalls from federal tax reform, Missouri went in a different direction, choosing to return money to taxpayers with individual income tax rate cuts.

Missouri had previously implemented the first of five triggered 0.1 percentage point reductions in its top marginal individual income tax rate, bringing the rate from 6.0 to 5.9 percent. The new law drops the rate to 5.5 percent next year, then allows the remaining triggers to play out. Subject to revenue availability, the rate would eventually reach 5.1 percent.

This is the top rate, of course: Missouri has a graduated-rate income tax. The bill actually consolidates one of the brackets, which will leave the state with nine brackets rather than 10. The reduction in the top rate impacts the vast majority of taxpayers, though, because those bracket widths are very narrow: the top rate kicks in around $8,000.

The bill also phases out the state’s partial federal deductibility for higher earners. Under federal deductibility, taxpayers can deduct a portion of their federal tax liability from income in calculating their state taxes. Only five other states have such provisions, and one–Iowa–has adopted legislation which will repeal it in a few years’ time.

Finally, it slightly curtails the ongoing phase-in of the state’s pass-through deduction, currently set at 5 percent of qualified business income. The deduction, similar to the new Section 199A deduction, was on a path toward 25 percent, but will now be capped at 20 percent. This represents progress, though the economic justifications for this substantial tax expenditure are slim.

When all is said and done, Missouri’s top individual income tax rate could be 5.1 percent while the corporate rate drops to 4 percent, the result of a separate piece of legislation which lowered rates, paid for by adopting a single apportionment factor (single sales factor) for most businesses rather than allowing them to elect the apportionment regime most favorable to them. (Apportionment refers to how a company’s income is divided up, for tax purposes, among multiple states.)

In the wake of federal tax reform, state tax competitiveness matters more than ever. Combined with legislation earlier this year giving Missouri one of the lowest corporate rates in the country, these income tax reforms will help the state stand out from its peers.

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