All Aboard the Tax Volatility Train

For more than three decades, the American tax system has chugged along smoothly.

Dear states, please state the state of your state

While federal reform was the media’s primary focus, another major consequence was the automatic impact of the new federal laws on state income tax laws.

Across the country, many states will raise more revenue (opens in new tab) (i.e., individuals will pay more state income tax) as a result of the new federal tax laws. This is especially the case for states that allow a personal exemption deduction, since it was repealed as part of federal tax reform. Consequently, most states will need to proactively pass new laws that either agree or disagree with the new federal tax laws. In some cases, states may decide to reduce tax rates to avoid collecting additional revenue. Or maybe they won’t. Only time will tell.

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Instead of minor tweaks to their tax laws, some states are following that same set of comprehensive tax reform tracks and considering significant changes to modernize their own tax codes. Iowa, for example, is debating its most comprehensive reform (opens in new tab) in decades.

As another possibility for reform, some states are trying to creatively offset the negative economic effects of the new federal laws. The primary cause for this effort is the $10,000 cap on deductions for state and local taxes. Taxpayers with high income and property taxes were negatively impacted by this limitation, and states such as New York, New Jersey, California and others are proposing to set up charitable funds where taxpayers can make donations (that would be fully deductible for federal income tax purposes), and then receive a credit back on their state income tax return. In essence, this allows taxpayers to substitute charitable gifts for income tax payments.

Taxes and creativity have long shared a productive history, and this effort is no exception. While this attempt to circumvent the new federal tax law may seem like an effort doomed to fail, New York recently passed such legislation (opens in new tab), and other states are aggressively pursuing a similar option. Passing the new law is one thing, but it’s likely the IRS will contest this effort, and litigation in court seems inevitable.

Volatility Means Opportunity

Major tax reform is not simple, and when done this quickly, there are bound to be issues that pop up. The 2017 Tax Act is really the start, not the end, of implementing broader reforms that will resonate throughout the entire country, every state and every household. But where there is volatility there is opportunity. Just like stock market volatility can present compelling opportunities to buy and sell investments, tax volatility over the coming years will likely present compelling opportunities to restructure your tax profile to possibly improve your current tax situation.

All of the turnover is bound to be a bit confusing, even for the experts, so be sure that you’re working with your financial adviser and tax specialists to stay up to date new opportunities. If you are planning to meet with a planning professional to discuss how volatile tax laws will impact your future, consider and discuss the following questions:

1. What is the longer-term impact of new tax laws on your finances?
2. How can you leverage new tax laws to minimize the share of your retirement assets that federal and state governments own?

This material is not a substitute for professional tax advice or services, nor should it be used as a basis for any decision or action that may affect your financial situation. Before making any decision or taking any action that may affect your situation, you should consult a qualified professional adviser.