Culver, Legislature face tax coupling issue again

DES MOINES -- Jobless Iowans, disaster victims, teachers and others will have money on the line when Gov. Chet Culver and state lawmakers wrestle with a taxing issue in the coming weeks.

Tens of millions of dollars are at stake for Iowa taxpayers and the state treasury over a decision whether to “couple” Iowa tax rules with federal tax code changes. The first signal on where a decision is headed could come when Culver issues his fiscal 2011 budget plan to the Legislature next week.

The already complex and vexing coupling issue -- still unresolved from the 2008 tax year -- is further complicated by the fact that state government is beset by shrinking revenue and an unprecedented budget gap forcing cost-cutting measures that reduce the likelihood of providing relief for targeted taxpayers this session, officials said.

“We're going through some really tough decisions in state government and additional things that cost big piles of money aren't likely to happen,” said Senate Majority Leader Mike Gronstal, D-Council Bluffs.

The issue dates back to last session when Democrats who control the Legislature decided not to adopt for state tax purposes a list of 2008 federal tax changes offering deductions, exemptions or other advantages for things like disaster-related expenses, business equipment depreciation, education-related expenses, college tuition and fees, or certain sales tax charges. The coupling issue at that time carried an estimated state budget impact topping $50 million.

However, the decision not to couple was not known until the Legislature adjourned in late April – meaning tax preparers and taxpayers were given mixed signals with some early-filing Iowans incorrectly claiming the federal benefits on their 2008 state returns while others did not, said Jim McNulty of the state Department of Revenue.

After that, some taxpayers were contacted by their tax preparation specialists that they may owe additional state tax or face returning part of any state tax refund they received for claiming federally adopted tax breaks that were not approved for state tax purposes.

However, Culver stepped in and directed state revenue officials to temporarily delay any enforcement against taxpayers who claimed disaster-related credits on their state tax returns that were not validated by Iowa lawmakers until the issue could be addressed this session.

In the meantime, Congress adopted additional 2009 federal tax changes that exempt the first $2,400 in unemployment compensation for jobless workers from taxation, allows educators to deduct up to $250 in out-of-pocket expenses, and make other changes that Culver and Iowa lawmakers again must decide whether to adopt for state tax purposes.

The state tax code update legislation (Senate Study Bill 3042) proposed by the Iowa Department of Revenue would conform the federal tax changes for the 2009 tax year but not make any retroactive provisions for 2008. McNulty said the price tag associated with the coupling issue would be less than last year “but it will still be significant.”

If lawmakers and the governor decide not to couple again this year or address the 2008 issues, McNulty said state tax collectors would begin compliance work by contacting taxpayers who may owe the state money for disallowed tax breaks they may have claimed on last year's Iowa returns.

“There's no question it's a confusing and complicated issue,” said McNulty, who estimated that a minority of Iowa's 2008 income-tax filers would be affected by the 2008 coupling outcome.

“It's just a mess,” said Sen. Randy Feenstra, R-Hull.

“It's got to be cleaned up. It's just that when you clean it up, it's going to directly affect the disaster relief victims and others,” he added. “It is going to add insult to injury to those flood victims who took the deduction.”

Along with the financial aspects, Feenstra said the unresolved coupling snafu is a fairness issue because, as it currently stands, Iowa taxpayers who filed incorrectly received an extra tax break while those who played by the rules are being penalized.

“If we do not act, the department has to act. They have to go back after that money,” he added.

Rep. Tyler Olson, D-Cedar Rapids, introduced legislation (House File 2088) last week that would waive any penalties and interest against taxpayers who filed a state return expecting Iowa would conform with federal income tax provisions. The bill only applies to disaster-related losses, but Olson said it could be amended beyond its initial scope.

Rep. Paul Shomshor, D-Council Bluffs, chairman of the House Ways and Means Committee, said nothing is off the table at this point but any decision on the tax coupling issue will have to be made in the context of the overall fiscal 2011 budget.

“We're going to have to take a look at it again like we did last year to see if we can afford to put this piece back in play,” said Sen. Joe Bolkcom, D-Iowa City, chairman of the Senate Ways and Means Committee.

Culver said he planned to discuss the tax coupling issue with lawmakers but the outcome likely would depend on efforts to squeeze sizable cost-savings from state government. Those include offering an early-retirement incentive for veteran state employees and implementing new efficiency, streamlining and reorganization measures, he said.

“We'll look at those things and we'll make an evaluation on whether we can afford to do those things,” Gronstal added.