When Kansas exempted pass-through income from state income tax beginning in 2013, the Department of Revenue estimated that 191,000 entities would take advantage of the provision, but the actual number of 330,000 claimants in the first year prompted media to declare that the exemption created a massive wave of tax evasion. Tax return data from the Internal Revenue Service, however, shows that the original estimate was mistaken.
According to KDOR Chief Economist Michael Austin, ” In 2011, when the tax policy was estimated, KDOR referred to Federally-held IRS data. The most recent dataset available at the time was for tax year 2009 and it had three categories of returns that would be considered as tied to a personal business; “Business or Profession Net Income”, “Number of Farm Returns”, and “Partnership/S-Corp Net Income”. The sum of these three business returns resulted in an estimate of 330,000 filers that would be impacted by the tax policy.”
There were 191,991 Schedule C proprietors in 2009, which is very close to the number of entities used in legislative and media discussions but including farm returns from Schedule F and other entities from Schedule E, Kansas actually had 329,511 total pass-through entities in 2009.
The Legislature’s override of the Governor’s veto will impose a $3 billion / 5-year income tax hike on Kansans. Marginal tax rates on all individuals are increased retroactive to January 1, 2017 and then hiked again in 2018. So not only will your employer have to withhold more from your paycheck starting July 1, you’ll either have to further increase withholding or write a check next April for the tax increase on your earnings for the first half of this year.
The rate on the first $15,000 single / $30,000 married taxable income jumps 15 percent by next year, going from 2.7 percent to 3.1 percent. A new second bracket on the next $15,000 single / $30,000 married taxable income goes up 14 percent and there’s a 24 percent increase of every dollar of taxable income thereafter. The rate increases for those who itemize will be partially offset by the phase in of deductions for mortgage interest and medical expenses (50 percent this year and next, 75 percent in 2019 and 100 percent in 2020.). The child care tax credit will be brought back in 2018 at 12.5 percent of the allowable federal amount and moving to 18.75 percent in 2019 and 25 percent thereafter.
The marginal rates may be lower but the sales tax and cigarette tax increases instituted since then remain in place. According to an analysis from the Kansas Department of Revenue, the net effect of all taxes changes between 2012 and 2016 was only a $393 million tax reduction for Fiscal 2018; the $591 million Kansas income tax hike just imposed for Fiscal 2018 means citizens will be $198 million worse off next year on net than in 2012.
Of the $3 billion total increase tallied by Kansas Legislative Research, the Kansas Department of Revenue says $1.2 billion is attributable to elimination of the pass-through exemption (presuming, of course, that none of those businesses pick up and leave). The remaining $1.8 billion tax increase means the ordinary citizens are stuck with 61 percent of the total increase.
The exemption on pass-through income for proprietors, partnerships, limited liability corporations (LLCs) and sub-S corporations is eliminated effective January 1, 2017. That income passes through to the individuals owners and is therefore taxed at the above marginal rates.
The Legislature also put many of the lowest earners back on the tax rolls. Previous law exempted the first $5,000 of taxable income for single filers and the first $12,500 for married filers; those exemptions are reduced to $2,500 and $5,000 respectively.
Is it true that making small businesses pay income tax would allow a lot more spending on education, highways and other services?
The Department of Revenue says reinstating the tax on pass-through income and their loss carryforward capability would generate between $195 million and $200 million. But as explained here that would only help get the state’s ending balance up to the statutorily-required level for at least two years, so there would be nothing left to pay for additional spending.
Data provided by the Kansas Department of Revenue shows 71 percent of net income tax reductions went to individuals and 29 percent is attributable to the exemption on pass-through business income. Their information is based on the 2013 tax year so even if the tax savings was the same each year, individual tax filers (excluding business filers) would have saved $2.1 billion through 2016.
I’ve been told that a ‘3-legged stool’ (income tax, sales tax and property tax) is the best way to fund government. It seems like cutting income tax creates a wobbly stool.
Actually, the data shows that government is far better off relying on sales tax and property tax because of the volatility in income tax. Over the two years following the 2008 recession, income tax collections (individuals, corporations and financial institutions) dropped 20.9% but retail sales and compensating use tax only declined by 5.1% and assessed valuation dipped by just 5.0%. Precipitous decline in income tax collections were the primary cause of General Fund spending being cut by $834 million between 2008 and 2010; the impact on services would have been much less severe if primarily funded by sales and property taxes.