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Federal Tax Changes may prompt State Tax Changes

For many, many years we have had an unlevel playing field when it comes to paying federal income tax. Whether you agree or not, does not matter. This truth is irrefutable. Historically, U.S. citizens that live and work in states with no state income tax have paid more federal income tax, than those with the same income that live and work in low state income tax states, who have paid more federal income tax than those with the same income that live and work in states with high state income tax, who have paid the very least amount of federal income tax on the same income.

Perhaps the easiest way to illustrate is like this. Consider three people with the same income. One is in a no tax state, one is in a low tax state and one is in a high tax state:

Income $100,000 less State Income Tax of $0 = Pay Federal Income Tax on $100,000

Income $100,000 less State Income Tax of $5,000 = Pay Federal Income Tax on $95,000

Income $100,000 less State Income Tax of $10,000 = Pay Federal Income Tax on $90,000

After the changes to the federal tax code, every U.S. Taxpayer will be able to deduct up to $10,000 for state income tax, sales tax or property tax.

Now these three people with the same income; One in a no tax state, one in a low tax state and one in a high tax state:

Income $100,000 less State Tax of $10,000 = Pay Federal Income Tax on $90,000

Income $100,000 less State Tax of $10,000 = Pay Federal Income Tax on $90,000

Income $100,000 less State Tax of $10,000 = Pay Federal Income Tax on $90,000

Flat Tax Comparison and the “Duck Test”

The effect is the same as if we implemented a FLAT TAX at the federal level. You would have the same result. Today I read that in New Jersey and California, top democratic officials want to let their residents make charitable contributions to their states instead of paying certain state taxes. I think this type of effort to circumvent the federal tax system would have a very hard time passing the “Duck Test” in tax court. If it looks like a duck, quacks like a duck, waddles like a duck, swims and flies like a duck, it’s a duck.

It is true that some states, Alabama included, gives a state tax credit for contributions made to private school scholarships and the IRS does allow a deduction for those charitable contributions. The major difference in this and the proposals California and New Jersey are considering, is the contributions go to a third party (the private schools) and not the state itself.

 

 

Gregory J. Cook, EA, CPA

Gregory J. Cook, EA, CPA

News from Cook & Co. Tax Advisors at 124 South Main Street in Arab, Alabama.
Gregory J. Cook, EA, CPA