Iowa’s taxation of married couples has quirks that can throw a taxpayer or tax preparer for a loop. For example, Iowa has 3 different filing statuses a married couple can choose from, and most deduction items are allocated pro rata between spouses who file separately. This results in situations where “common sense” would say one thing but Iowa’s tax law says something else.
We’ll discuss these quirks in a series of blog posts over the coming months. These posts are excerpts from a CPE presentation I give to tax professionals on this topic.
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(This presentation is broken into a series of “Issues.” These are issues 11 and 12.)
Issue 11: Net Income and the Requirement to File an Iowa Tax Return
Iowa law says taxpayers with net income of less than $13,500 (or $32,000 for people over age 65) are not required to file a tax return. Married couples filing separately must combine their net incomes in order to determine if they meet this threshold.
Example:
Alex and Angie are over age 65. Alex’s net income is $20,000. Angie’s net income is $15,000. Separately, they are both below the $32,000 filing threshold, but for purposes of determining a filing requirement for married filing separately, Alex and Angie must combine their income. Their combined income of $35,000 is above the filing threshold, so they’re required to file a tax return.
Issue 12: Federal Tax Refunds
Iowa law requires taxpayers to claim their prior-year federal tax refund as income in the current year. For example, a taxpayer receiving a federal refund on a 2016 tax return (filed in 2017) will report that refund as income on their 2017 Iowa tax return.
Married couples filing separately will need to allocate the refund based on net income for the year the refund applied to.
Example:
Angie and Alex received a $1,000 federal refund on their 2016 tax return, filed in 2017. On their 2016 Iowa tax return, Angie’s net income was $40,000, while Alex’s was $60,000.
On their 2017 Iowa tax return, Angie and Alex will report the $1,000 refund as income and will split it based on their 2016 Iowa net income. Angie will report 40% of the refund while Alex will report 60%.
What if the refund comes from a separately-filed federal return, or the taxpayers weren’t married for the year the refund applies to? In that case, each spouse reports their own refund in full.
Example:
Angie and Alex get married in 2016. On their 2015 tax returns, filed as two single people, Angie receives a $500 refund and Alex receives a $600 refund. When they file their 2016 Iowa tax return as a married couple, Angie will report her $500 refund in full, and Alex will report his $600 refund in full.
The same concept applies to couples who file separate federal returns.
Example:
Assume the same facts as the last example, except Angie and Alex were married in 2015 and filed separate federal returns. Since the refunds on the 2015 returns came from separately-filed returns, Angie will report her $500 refund in full and Alex will report his $600 refund in full.
(NOTE: the “tax reform” bill passed recently by the Iowa legislature would eliminate all of this starting in 2023 … but only if certain revenue targets are met. If — and it’s a big if — the revenue targets are met, then the ability to deduct federal taxes would go away, which would thus eliminate the need to recapture federal refunds as income in future years.)