By now you’ve read about the TCJA cap on the federal tax deduction for state and local taxes. This limitation had been vigorously contested prior to passage of TCJA and was an issue many senators and representatives sought to change. Subsequently, some states are considering their options. However, the biggest issue facing state governments, as they tackle waning revenues, is not the limitation on state and local tax deductions at the federal level, but whether to modify their tax regulations. This is particularly painful for certain states that link their state income tax to the federal rules. Delaware is one of those states. Given that it will be inevitable that certain federal spending programs will be impacted by TCJA’s anticipated $1.5 trillion federal deficit increase (over 10 years), the question to be answered is how will state governments, particularly those that link to the federal tax rules, reach?
Traditionally, using federal rules and definition simplifies filing requirements for taxpayers, while simultaneously providing a built-in foundation for determining taxable income and other tax attributes for state regulators. The issue is whether to continue to link to the federal rules or pass a law to decouple from federal legislation. There are, of course, other measures that state governments can take. One would be to raise the tax rate. The second option would be to reduce government services.
How exactly states will reach is too early to tell, but we will keep you updates as things change. Needless to say the dilemma is real and at best, enormous!