A Look at Iowa's Rolling Conformity with Federal Tax Law
It’s been difficult enough to keep up with federal tax changes this year, let alone worry about how Iowa is treating these changes. Confusion has been complicated by the fact that many software companies have not adjusted their products to comply with Iowa law. The good news is that, although not always clear-cut, Iowa's rolling conformity has made things a bit easier, even if it doesn't feel like it.
In this post, we provide a brief review of the interaction between Iowa tax law and the federal Internal Revenue Code.We close with a discussion of Iowa's current treatment of several federal tax provisions commonly arising on 2020 returns. In several instances, we advise taxpayers to wait for further developments before filing impacted returns.
Note: On March 29, the Iowa Department of Revenue announced that it was delaying the Iowa filing deadline for individuals to June 1. Order 2021-01 allows Iowa residents or non-resident individuals required to file Iowa returns an extension for filing the IA 1040 Individual Income Tax Return and all supporting forms and schedules, and any associated tax payments, including quarterly estimated income tax payments due April 30, 2021. The Order does not include business filers and other tax types for individuals. See this post or more details.
A Brief Review of Iowa’s Conformity with Federal Tax Law
For the 2018 tax year, Iowa law continued to point to the federal tax code as it existed on January 1, 2015, with some adjustments. This meant that many provisions from the Tax Cuts and Jobs Act, for example, were not recognized in Iowa.
Tax Year 2019
For tax year 2019, Iowa implemented static conformity. This meant that Iowa followed the federal tax law as it existed on March 24, 2018, with some adjustments. Iowa Code § 422.3(5)(a). So, for 2019, Iowa was fairly closely conformed, but Iowa did not automatically conform to any new federal provisions that came along after March 24, 2018, impacting the 2019 tax year.
Example: Borrowers who received Paycheck Protection Program loans during a tax year beginning in 2019 could not exclude the forgiven loans from income without a legislative fix. That legislative fix took place last summer. Those same taxpayers, however, are not currently allowed to deduct expenses paid with this tax exempt income because for tax year 2019, Iowa has not conformed to the Consolidated Appropriations Act, 2021 (CAA), which made these expenses deductible for federal law. A legislative fix for this problem, SF 364, remains pending before the Iowa Senate.
Tax Year 2020
Tax year 2020 ushered in a new and helpful approach. For tax years beginning on or after January 1, 2020, Iowa’s definition of the Internal Revenue Code matches the current Internal Revenue Code. Iowa Code § 422.3(5)(b). This means that as federal tax law changes, Iowa tax law automatically points to the new law. Called “rolling conformity,” the approach works like this: Unless the Iowa Legislature has written a contrary provision, Iowa tax law will conform to the federal law.
What does this mean? As stated in the instructions for the 2020 Iowa Form 1040, “For the most part, the calculation of Iowa net income is still the same as the calculation for federal adjusted gross income (AGI). However, the calculation of Iowa net income will be different from the federal AGI calculation when it comes to certain items described later in these instructions.” The Form 1040 instructions detail adjustments for provisions like bonus depreciation and net operating losses for which Iowa strays from federal treatment. These are specific provisions for which the Iowa Legislature has provided a different law.
Example: Borrowers who received Paycheck Protection Program loans during the 2020 tax year are able to automatically exclude these forgiven loans from income. When the federal CAA allowed taxpayers to take deductions for expenses paid with these proceeds, Iowa law automatically follows that treatment. Iowa net income generally lines up with federal AGI, absent a specific Iowa provision changing that treatment.
Determining Iowa Taxable Income for 2020
Iowa Code § 422.4(16) defines “taxable income” for individuals as the net income defined in Iowa Code § 422.7 minus the deductions allowed by Iowa Code § 422.9.
The starting place to find Iowa-specific adjustments is Iowa Code § 422.7, the subsection of the Iowa tax law that tells us how to calculate Iowa net income. This provision defines Iowa net income as “the adjusted gross income before the net operating loss deduction as properly computed for federal income tax purposes under the Internal Revenue Code with the following adjustments…” The subsection then lists a number of Iowa-specific provisions the Iowa Legislature has adopted throughout the years. These include items such as decoupling from federal bonus depreciation and the federal business interest deduction limitation. Newly arising Iowa-specific income exclusions are added to this section as they arise.
Iowa Code § 422.9 details Iowa-specific deduction rules. These include, for example, Iowa’s standard deduction vs the itemized deduction, and special Iowa treatment for the federal qualified business income deduction and the net operating loss deduction. Iowa’s itemized deductions begin by allowing a deduction for the “total of contributions, interest, taxes, medical expense, nonbusiness losses, and miscellaneous expenses deductible for federal income tax purposes under the Internal Revenue Code, with the following adjustments…” Specific adjustments include, for example, an add-back for Iowa income taxes paid and a deduction for federal income taxes paid.
Iowa law also provides a number of Iowa-specific tax credits, some calculated based upon a specific percentage of a federal credit, but most available only in Iowa. These credits generally reduce the tax liability calculated under Iowa Code § 422.5 and Iowa Code § 422.5A.
Taxation of Unemployment Compensation
The American Rescue Plan Act exempts from federal income taxation up to $10,200 of unemployment compensation for those with AGI below $150,000.
Iowa Treatment: Absent a change in law by the Iowa Legislature, this income will also be exempt from Iowa taxation. This exclusion is part of the federal AGI calculation, with which Iowa generally conforms in 2020. Iowa SF 364, as amended by H-1122, unanimously passed the House on March 3. This House amendment would exclude federal pandemic unemployment insurance income from Iowa income. The Senate has not openly debated this provision since it returned from the Iowa House. Given the intervening passage of the ARPA, we are watching for further developments. It is advisable to hold impacted Iowa returns, pending reporting instructions from the Iowa Department of Revenue. Those who have already filed (without the income exclusion) should also await further instruction. IRS has instructed taxpayers how to report the income exclusion on a webpage updated March 24. On that same page, IRS says, "If you have already filed your 2020 Form 1040 or 1040-SR, you should not file an amended return at this time. The IRS will issue additional guidance as soon as possible." Iowa taxpayers should not file amended Iowa returns either, but instead await further guidance from IDOR.
Update: On March 29, 2021, IDOR provided instructions for reporting 2020 unemployment compensation.
Excess Deductions Upon theTermination of an Estate or Non-Grantor Trust
The Tax Cuts and Jobs Acts prohibited individuals, estates, and non-grantor trusts from claiming miscellaneous itemized deductions for any taxable year beginning after December 31, 2017, and before January 1, 2026. It was then unclear whether beneficiaries could continue to deduct excess deductions upon the termination of an estate, as they had in the past. After some earlier reticence, the IRS issued final regulations in September of 2020, clarifying that the following deductions are allowable in figuring adjusted gross income and are not miscellaneous itemized deductions:
- Deductions for costs paid or incurred in connection with the administration of the estate or trust which would not have been incurred if the property were not held in such estate or non-grantor trust.
- The deduction concerning the personal exemption of an estate or non-grantor trust.
- The distribution deductions for trusts distributing current income.
- The distribution deductions for trusts accumulating income.
The guidance also states that these excess deductions may be passed through to beneficiaries upon the termination of an estate or a non-grantor trust. Federal Form 1040 instructions for 2020 state that these deductions should be reported on line 22 of the federal Form 1040:
Excess deductions of section 67(e) expenses from Schedule K-1 (Form 1041), box 11, code A. Identify as "ED67(e).
Iowa Treatment: For 2020, Iowa conforms with the federal treatment of these deductions. It appears that Iowa conforms to the federal treatment for 2019 as well (stay tuned for further guidance). In 2018, Iowa did not conform to the TCJA, so the excess deductions were allowed as a deduction on the Iowa return as they had been prior to the TCJA.
Personal Casualty Loss Deductions in a Federal Disaster Area
The CAA expanded the definition of a “qualified disaster loss” to include an individual's casualty and theft of personal-use property that is attributable to a major federal disaster that was declared before February 26, 2021, by the President under section 401 of the Stafford Act and that occurred on or after December 28, 2019, and on or before December 27, 2020, and continued no later than January 26, 2021. This law covers the Iowa derecho.
Under federal law, taxpayers who suffered a “qualified disaster loss” are eligible to claim a casualty loss deduction, to elect to claim the loss in the preceding tax year, and to deduct the loss without itemizing other deductions on Schedule A (Form 1040). Net casualty losses from these qualified disasters do not need to exceed 10 percent of adjusted gross income (AGI) to qualify for the deduction, but the $100 limit per casualty is increased to $500.
Iowa Treatment: For the 2020 tax year, Iowa is conformed to the federal treatment of these qualified disaster losses. For tax years 2018 and 2019, Iowa did not conform to federal treatment of qualified disaster losses.
Employee Retention Credit
This is a federal payroll credit made available to employers who have been impacted by COVID-19. Federal law provides that this credit is excluded from income, but the corresponding wages are not deductible. The CAA made the ERC retroactively available for some businesses who received a PPP loan in 2020. It also expanded and extended the credit into 2021. The ARPA has now made the ERC available through December 31, 2021.
Iowa Treatment: Because this is a federal credit, Iowa has no corresponding tax benefit. Under current law, however, Iowa conforms to the federal tax treatment of this provision. This means that the credit is not included in income, but the corresponding deduction for wages is disallowed. The Iowa Legislature would have to pass a law to allow these wages to be deductible under Iowa law. Such a provision exists for the work opportunity credit, but not for the ERC.
Families First Coronavirus Response Act Credits
The federal law provides sick leave and family leave payroll credits to employers that provide paid leave to their employees who are unable to work because of specific COVID-19 related reasons. Federal law includes these credits in the income of the employer and allows the corresponding wage deduction.
Iowa Treatment: This is a federal credit for which there is no Iowa counterpart, but Iowa conforms to the federal tax treatment of the credit for tax years beginning on or after January 1, 2020: The credit will be included in income and the wages will be deductible.
Coronavirus Related Distributions
Section 2202(a) of the CARES Act provided taxpayers with special treatment for coronavirus-related distributions from eligible retirement accounts. For qualifying distributions (up to $100,000), the law:
- Provides an exception to the 10% penalty for early withdrawals,
- Allows the distribution to be included in income ratably over 3 years, and
- Provides that the distribution will be treated as though it were paid in a direct rollover to an eligible retirement plan if the distribution is eligible for tax-free rollover treatment and is recontributed to an eligible retirement plan within the 3-year period beginning on the day after the date on which the distribution was received.
Iowa Treatment: Because these provisions impact adjusted gross income and the Iowa Legislature has not passed an exception, Iowa law conforms to federal law with respect to the tax treatment of coronavirus related distributions.
Paycheck Protection Program
The CAA provides that no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the income exclusion for forgiven PPP loans. If forgiven, PPP loan proceeds are excluded from gross income and related deductions are allowed. Additionally, partners and S corporation shareholders will increase their basis in the entity by the amount of the forgiven loan proceeds, thereby preserving the tax-free nature of the proceeds at the owner level.
Iowa Treatment: On February 4, 2021, the Iowa Department of Revenue issued guidance on its nonconformity with the Consolidated Appropriations Act of 2021, as it applies to taxpayers with tax years beginning before January 1, 2020. Specifically, for any tax year beginning on or after January 1, 2020, Iowa is conformed with the income exclusion for forgiven PPP loans, as well the provisions of section 276(a) and 278(a). In other words, for tax year 2020 and beyond, a taxpayer’s income tax treatment of PPP loans and related expenses should be the same on their Iowa tax return as it is on their federal tax return. Related business expenses are deductible.
Issue for 2019 Fiscal Year Taxpayers
The guidance, however, provides that while forgiven loan proceeds are excluded from income for tax year 2019 (because of a legislative fix in June of 2020 for fiscal-year filers), the related expenses are not deductible. These taxpayers (unless the Iowa Legislature acts to change the rule) must add back business expenses to their IA 1010 Nonconformity Adjustments form, line 12, for tax year 2019. As of the time of this writing, Iowa SF 364, as amended by H-1122, remains pending in the Senate. The bill would allow fiscal year entities with tax years beginning in 2019 to deduct expenses paid with later forgiven loan proceeds. The bill originally passed the Senate, and then unanimously passed the House on March 3, with an amendment (dealing with unemployment compensation and Iowa COVID-19 grants). It is now before the Senate for reconsideration. It is advisable to hold these returns pending resolution of this issue.
Economic Injury Disaster Loan (EIDL) Advances
In 2020, some farmers and small businesses received Economic Injury Disaster Loans (EIDL) from the SBA. Although these loans were not forgivable, the CARES Act allowed those who applied for such a loan (whether or not they actually took out the loan) to receive an EIDL advance. This was a grant in an amount up to $10,000. The SBA limited to grant to $1,000 per employee, up to a total of $10,000, for eligible businesses. In mid-2020, Congress specifically granted permission for farmers to receive EIDL loans and EIDL advances.
Under the CARES Act, an EIDL advance was not excluded from gross income. The EIDL advance also reduced the amount of PPP forgiveness a borrower could receive. In other words, if a farmer received a $100,000 PPP loan and a $10,000 EIDL advance, the CARES Act required the farmer’s PPP loan forgiveness to be restricted to $90,000.
The CAA changed these rules retroactively. Under current federal law, EIDL advances are excluded from gross income and corresponding expenses remain deductible. Additionally, PPP loan forgiveness is not reduced in the amount of the EIDL Advance.
Iowa Treatment: Iowa couples fully with these provisions for tax years beginning in 2020.
Iowa CARES Act Grants
Many farmers and small businesses received other grants funded by CARES Act money provided to Iowa. Such programs included the Livestock Producer Relief Fund and the Beginning Farmer Debt Relief Fund. These grants are not excluded from gross income under federal law. As such, they should be reported as regular farm income on the Schedule F. State treatment of these grants may vary.
Iowa Treatment: Although these grants are currently taxable under Iowa law, Iowa SF 364, as amended by H-1122, passed by the House on March 3, would exclude these grants from Iowa taxable income. It may be advisable to hold these returns until it is determined whether this bill will become law.
Stay tuned for further updates. In particular, we are watching developments related to the meaning of the ARPA provision prohibiting states from using any of their $350 billion in recovery funds to cut taxes. This could impact legislation pending in the Iowa Legislature.
The Center for Agricultural Law and Taxation does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. The Center's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.