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U.S. states look to tax day to gauge fallout from federal tax law

[April 19, 2018] By Karen Pierog

CHICAGO (Reuters) - Taxpayer actions in response to sweeping federal tax changes passed by the U.S. Congress late last year will likely force states that tax personal income to tear up their revenue forecasts and start again.

The federal tax bill, signed into law by President Donald Trump on Dec. 22, hit most states smack in the middle of their current fiscal year. Uncertainty about future revenue can force states to revise their spending plans in turn.

(GRAPHIC: Tax law changes alter taxpayer behavior - https://tmsnrt.rs/2J8yKdL)

The fallout from the law's lower federal tax rates and big changes to deductions that take effect with the 2018 tax year will become clearer in the aftermath of this week's tax filing deadline, allowing states to revise revenue projections for the current and upcoming fiscal years.

"There's so much going on with this tax act that states are having a difficult thing figuring out what's going on," said Ron Alt, senior manager of research at the Federation of Tax Administrators.

PREPAID TAXES, INCOME SHIFTING

Because the federal law does not affect 2017 tax returns, some taxpayers took action late last year to maximize deductions of state and local taxes on property, sales and income (SALT)on their tax returns before the new law caps them at $10,000.

The looming cap set off a stampede in some states by homeowners who itemize their federal returns to prepay property taxes due in 2018. These prepayments were added to property taxes due and paid in 2017 in order to bulk up on non-capped 2017 deductions.

The rush was tempered by an Internal Revenue Service advisory issued on Dec. 27 that warned: "A prepayment of anticipated real property taxes that have not been assessed prior to 2018 are not deductible in 2017."

In Illinois' largest county, Cook, which includes Chicago, $757 million, or 11 percent of first installment property taxes, were prepaid, according to County Treasurer Maria Pappas' office.

There was also a huge jump in estimated income tax payments by high-income earners seeking to maximize deductions in 2017 before the cap takes effect and a cut in federal income tax rates diminishes the value of deductions in 2018, according to the Rockefeller Institute of Government, which tracks state revenue.

Estimated tax payments, which usually involve investment income, rose an unprecedented average of 69 percent in December versus December 2016.

"We have never seen such a growth rate in a single month," said Lucy Dadayan, the institute's senior research scientist, adding that the surge is likely to result in big tax refunds that will deflate tax collections.

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President Donald Trump displays his signature after signing the $1.5 trillion tax overhaul plan in the Oval Office of the White House in Washington, U.S., December 22, 2017. REUTERS/Jonathan Ernst/File Photo

While capping SALT deductions was seen largely affecting high-tax Democratic so-called blue states like California and New York, estimated tax payments were up an average of 46.7 percent for the December-January period in 37 states, including Republican red states, Rockefeller Institute data showed.

A majority of states, 41, tax wages and salaries, while two - New Hampshire and Tennessee - only tax dividend and interest income, according to the Tax Foundation. Seven states - Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming - do not levy an income tax.

Personal income taxes make up slightly more than a third of states' total general fund revenue, and sales taxes comprise roughly another third.

For fiscal 2018, which ends for most states on June 30, an average increase in personal income tax collections of 7.2 percent over fiscal 2017 was forecast for 36 states for which the Rockefeller Institute has data. Projections for fiscal 2019 call for an average 3.3 percent increase.

CALIFORNIA COLLECTIONS BEAT FORECAST

In California, personal income tax collections of $13.065 billion in January were 22.4 percent over the forecast for the month, with the state attributing the increase in part to taxpayer reaction to the federal tax law.

H.D. Palmer, a spokesman for the state's finance department, said California will update its revenue forecast next month for the current budget and for the proposed fiscal 2019 spending plan Governor Jerry Brown unveiled in January.

"At this point we can't say what the impact (from the federal tax law) would be. It's still a work in progress," he said, adding that the state should have a clearer picture by the end of April.

(Reporting by Karen Pierog; additional reporting by Hilary Russ and Laila Kearney in New York; Editing by Daniel Bases and Jonathan Oatis)

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