On February 6, Patrick Anderson, CEO and Principal of Anderson Economic Group, sent a letter to United States Secretary of Treasurer Steve Mnuchin regarding the recently passed Tax Cuts and Jobs Act. In the letter, Mr. Anderson urged prompt action to prevent confusion on state income tax laws that reference the federal definition of exemptions.
February 6, 2018
Mr. Steve Mnuchin
Secretary, United States Treasury
1500 Pennsylvania Ave NW
Washington, DC 20220
RE: Tax Cuts and Jobs Act: Treasury Actions to Clarify Consequences for State Exemptions
Dear Mr. Mnuchin:
As you are aware, the federal Tax Cuts and Jobs Act adopted into law in late December has enormous implications for federal taxation and for the US economy. It also has implications for state taxation. I am writing you to alert you to an emerging problem among states that reference the Internal Revenue Code in their state income tax laws. I request that the Department of Treasury take prompt action to prevent confusion among taxpayers, erroneous assertions that the federal law causes large state tax income increases, and differences in application of the same provision among different states.
State Income Tax Laws that Reference Federal Definitions of Exemptions
Analysts at Anderson Economic Group have identified 41 states that impose a state income tax. Of these, at least 22 states reference section 151 of the Internal Revenue Code in state statutes. Section 151 establishes exemptions for federal income tax. These exemptions have wide importance in both state and federal tax laws.
As you are aware, the federal Tax Cuts and Jobs act amended Section 151 to set the federal personal exemption amount to zero through the year 2025, for federal income tax purposes only. The same amendment is explicit that this change does not eliminate the exemption for any other purpose, and indeed the law continues to require the indexing of the exemption amount for other purposes.
Issue Arising in Some States; Our Interpretation
This zeroing out of the exemption for federal income tax purposes in certain years raises a possible ambiguity in state income tax laws: does this mean that state tax exemptions, and other areas where state tax deductions and credits may reference federal statute (such as state earned income tax credits, child credits, financial aid forms, etc.) have been eliminated?
In statutes that we have reviewed across several states, we do not believe that to be the case. In our opinion, the Tax Cuts and Jobs Act is explicit that the exemptions remain in place for all purposes—including for determination of state income taxes—despite their reduction to zero for the calculation of federal income tax liabilities for tax years 2018 through 2025.
However, we are aware of the possible ambiguity, and undertook the effort to write to the Treasurer or other responsible official in the states of Michigan, Illinois, and New York, as well as the City of New York regarding this issue.
Differing Statements Among States; Assertions of “Tax Increases” Due to Federal Law
The initial letter, dated December 29, 2017, was sent to Nick Khouri, Treasurer for the State of Michigan. In this letter, I noted the possible ambiguity, explained our argument that the exemptions remained in place and should be recognized under Michigan’s income tax laws, and asked for a formal statement from the State on this question.
The Michigan Treasurer responded promptly, and stated that he agreed the federal exemptions remained in place; however, in his interpretation, Michigan’s state income tax exemptions would still go away because Michigan statute specifically allows exemptions that are allowable on the federal income tax return. He assumes that taxpayers will not be asked to enumerate exemptions on their federal income tax return, and implies that the state exemption would not go away if taxpayers were required to do so.
Under Mr. Khouri’s interpretation, the Tax Cuts and Jobs Act will eliminate Michigan income tax exemptions without state legislative action, resulting in a $1.4 billion increase in state income taxes. Michigan leaders and the legislature have responded by proposing a raft of different changes in law.
A similar situation has occurred in Maryland. A bill recently proposed in the Maryland legislature would amend the statute that establishes that state’s income tax exemption to avoid what Maryland legislators believe would be a $680 million tax increase.
We do not yet have responses to our letters to Illinois, New York State, and New York City. However, our estimates of the potential total tax increase that would occur if all of these states and cities were to impose income tax on the basis of a zero-amount state and local exemption easily exceed another $1 billion per year.
Requested Public Statement
Contrary to the opinions expressed by Michigan’s and Maryland’s leadership, we do not believe that these exemptions have been eliminated by the federal tax reforms, as we explain in “Anderson Economic Group Interpretation of Federal Law” on page 4. However, the actions in Michigan and Maryland demonstrate that opinions differ on the legal interpretation of these statutes—with a lot at stake.
In addition, in our review of statutes in the 22 states that refer to section 151 of the Internal Revenue Code, we found four states that had similar language as that in Michigan statute which led the Michigan Treasurer to conclude state exemptions will be eliminated (i.e. state statute refers to exemptions enumerated on federal tax returns). Those four states are Louisiana, Nebraska, New York, and Utah.
I request that the IRS take action to provide certainty to state legislators, taxpayers, and administrators regarding the effect of the Tax Cuts and Jobs Act on the existence of federal tax exemptions and their continued use on federal tax returns. In particular, I request the following:
- Communicate to the public, and in particular to the states listed in the foregoing discussion, whether the Department of Treasury understands federal law as continuing to establish tax exemptions under Section 151 of the Internal Revenue Code.
- Declare whether or not the Department of Treasury will continue requesting information on the number of exemptions a taxpayer can claim on federal income tax returns.
I appreciate your prompt attention to this matter.
Previously, Mr. Anderson sent a letter to Michigan Treasurer Khouri, and other government leaders in the State of New York, New York City, and Illinois requesting clarification. 5 days after the letter was sent to Treasurer Khouri, Anderson Economic Group received a prompt response. For more information on these letters, see here