Iowa Governor Signs Tax Reform into Law
On March 1, 2022, Governor Kim Reynolds signed HF 2317 into law. The new tax law will reduce individual and corporate income tax rates, provide exemptions from Iowa tax for certain forms of retirement income--including retired farmer rental income--and scale back certain tax credits. These changes have different effective dates, but most changes will begin phasing in during the 2023 tax year. This post summarizes key provisions of the new law.
Division I – Sale of Certain Qualified Stock – Net Capital Gain Exclusion
The new law modifies Iowa Code § 422.7 to exclude from taxation capital gain arising from the sale or exchange of some employee-owned stock. Specifically, employee-owners of a “qualified corporation” can make an election to exclude from Iowa taxation the capital gain from the sale of their stock. This irrevocable election will apply to all future sales or exchanges of stock from one qualified corporation. For qualifying sales and exchanges, the capital gain subject to tax is reduced as follows:
2023 33 percent reduction
2024 66 percent reduction
2025 and beyond 100 percent reduction
Employee-owner means an individual who owns capital stock in a corporation for at least 10 years. The common or preferred stock must have been acquired by the individual while employed and on account of the employment for at least 10 cumulative years. Qualified corporations must have been in business in Iowa for at least 10 years and must have had at least five shareholders for the 10 years prior to the first sale or exchange. The corporation must also have had a least two shareholders who are not related during that 10-year period.
Division II – Retired Farmer Lease Income Exclusion
The new law amends Iowa Code § 422.7 by adding a new subsection to allow a retired farmer-landlord ("eligible individual") to elect to exclude from Iowa income taxation the net income received under a farm lease covering real property. To be eligible for this election (beginning in 2023), the lessor must meet all of the following requirements:
- Be disabled or 55 years of age or older
- No longer be materially participating in the farming business
- Owned the real property and materially participated in a farming business for 10 or more years
The exclusion applies only to income from written farm tenancy agreements, including cash leases, crop share leases, and livestock share leases. The law does not apply to rental income received as an owner of an entity taxed as a partnership, an S corporation, or a trust or estate, even if the net income passes through to the eligible individual.
Note: This provision would appear to allow the exclusion to apply to income from land owned by a single-member LLC, but not to income from land held by an LLC taxed as a partnership (i.e. an LLC comprising only spouses).
The law directs the Iowa Department of Revenue to create rules to determine when a surviving spouse can claim the income deduction.
Individuals who make an election under this section may not:
- Apply the Iowa capital gain deduction to proceeds from the sale of farm in the current or succeeding tax years (see Division III below for new relevant law).
- Take the beginning farmer tax credit in the current or succeeding tax years
This provision applies to tax years beginning on or after January 1, 2023.
Division III – Retired Farmer Capital Gain Exclusion
The law modifies the capital gain deduction allowed for the sale of real property used in a farming business, beginning in tax year 2023. This provision is found in Iowa Code § 422.7(21).
Laws passed in 2018 and 2019 would have restricted the availability of the Iowa capital gain deduction beginning in 2023 to sales by those who met these conditions:
- Materially participated in a farming business for 10 years (retired farmers could qualify by showing they materially participated in 5 of the 8 years prior to retirement) and held the property used in a farming business for a minimum of 10 years OR
- Sells property held and used in a farming business to a relative, including lineal descendants and relatives, to the second degree.
The new law modifies these conditions to allow disabled or retired farmers (must be 55 years or older) to qualify for the Iowa capital gain deduction if they materially participated in a farming business for 10 years or more in the aggregate before making an election to take the deduction. The other requirements remain the same.
The law also allows retired or disabled farmers (55 years of age or older) to deduct gain from the sale of breeding, draft, dairy or sport cattle or horses (held for 24 months or more) if the taxpayer:
- Materially participated in the farming business for five of the eight years preceding retirement or disability, and
- Sold all or substantially all of the taxpayer’s interest in the farming business when the election is made.
The same rule will apply to the sale of other breeding livestock held for a period of 12 months or more.
Retired farmers may make a single lifetime election to exclude all qualifying capital gains under these provisions. However, retired farmers who elect to exclude gain under this provision may not claim the beginning farmer tax credit or the exclusion for net income received from a written farm tenancy agreement (as described in Division II above) in the current or any subsequent tax year.
This provision applies to sales occurring on or after January 1, 2023 (no revenue targets must be met).
Divisions IV and V – Individual Income Tax Rates
The top individual income tax rate in Iowa in 2022 is 8.53 percent. This rate applies to income over $78,435. The 2018 tax reform legislation set the top individual tax rate for 2023 and beyond at 6.5 percent. The new 2022 law significantly reduces future individual income tax rates, beginning in 2023. It also reduces the number of tax brackets in 2023 through 2025 and implements a flat tax in 2026. The law modifies Iowa Code § 422.5(3)(b) to lower the top rates as follows:
2023 6 percent (graduated)
2024 5.7 percent (graduated)
2025 4.82 percent (graduated)
2026 and beyond 3.9 percent (flat)
The law also modifies the alternate tax rate, by gradually reducing it to 4.4 percent in 2026 and beyond.
Division VI – Retirement Income Tax Exemption
Beginning in 2023, Division VI of the new law modifies Iowa Code § 422.5(3)(a) to exempt from Iowa taxation all “retirement income” for those who are disabled or 55 years of age or older. It also exempts retirement income received by a surviving spouses. Current law exempts retirement income only in an amount up to $6,000 for singles, and $12,000 for those who are married filing jointly. The new law does not change the full income exclusion for military retirement benefits paid by the federal government at any age.
Retirement income includes the total amount of a governmental or other pension or retirement pay, including, but not limited to, defined benefit or defined contribution plans, annuities, individual retirement accounts, plans maintained or contributed to by an employer, or maintained or contributed to by a self-employed person as an employer, and deferred compensation plans or any earnings attributable to the deferred compensation plans.
Under the new law, retirement income is also excluded when calculating net income for the purpose of determining whether an Iowa income tax return is required or whether the alternate tax is imposed.
This provision applies beginning with the 2023 tax year.
Division VII – Research Activities Tax Credit
This provision will raise revenue by limiting the research activities credit. Specifically, the law amends Iowa Code § 15.335(4)(a) to reduce the credit refundability by 10 percentage points each year from 2023 through 2027. This lowers refundability from 100 percent to 50 percent in 2027 and later.
The law disallows supplies and computer expenses from qualifying expenses when calculating the credit. It also requires the use of the alternative simplified method of calculation for state purposes if the taxpayer used that calculation for federal purposes.
Division VIII – Other Tax Credit Changes
The law also modifies the following tax credit programs:
- High quality jobs tax credit (Research Activities Credit takes priority)
- Geothermal heat pump tax credit (no new awards beginning in 2023)
- Endow Iowa tax credit (reduced to $100,000 from $300,000 per taxpayer)
The law also reduces the refundability of the following credits by five percent each year from 2023 through 2027 and after (for a final refundability of 75 percent):
- Assistive Device Tax Credit
- Historic Preservation Tax Credit
- Redevelopment Tax Credit
- Third-Party Developer Tax Credit
- Supplemental Research Activities Tax Credit
Division IX and X – Corporate Income Tax Rates
These provisions modify Iowa Code § 422.33(1) to reduce the top corporate tax rate over a number of years beginning with tax year 2023. The process involves evaluating revenue generated through corporate taxes beginning with tax year 2022. If that amount exceeds $700 million, the law will require a rate reduction based upon the rate that would have generated $700 million in that year. This process will continue until the corporate tax rate is a 5.5 percent flat tax rate.
Note: The top corporate tax rate in 2022 is 9.8 percent.
Division XII – Taxpayer Relief Contingent Transfers
This provision amends Iowa Code § 8.54(5) to transfer funds from the Iowa Taxpayer Relief Fund to the General Fund if both of the following are met:
- The ending balance of the State General Fund is less than 1 percent of the adjusted revenue estimate for the fiscal year
- State General Fund revenues (including transfers to the General Fund) is less than 103.5% of the General Fund actual receipts from the prior fiscal year
This transfer provision is effective beginning with fiscal year 2024.
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