Impact of Utah state income tax changes on federal income taxes
Several people have asked us if the recent Utah income tax changes will impact federal income taxes. For those who itemize deductions on federal income taxes, the answer is yes. Federal taxes will be increasing as a result of state income tax cuts. That's because Utahns who itemize will have have higher federal taxable income because they are deducting less state income tax. Bad news, but that's the way it works.
The state income tax cut will be larger than the federal income tax increase. Most Utahns with full-time jobs are in the 15% federal income tax bracket. The 15% bracket for tax year 2007 begins at $15,650 and ends at $63,700. Remember that this is TAXABLE income, which is adjusted gross income less exemptions and deductions. Therefore, for each dollar reduction in state income taxes, federal income taxes will increase by 15 cents.
Higher income Utahns will see an even higher increase in federal taxes because they are in higher federal income tax brackets. The highest marginal tax rate is 35% and begins at taxable income of $349,700 (tax year 2007). However, since itemized deductions are phased out for higher income taxpayers, these taxpayers will experience a federal tax increase of a little less than 35 cents for every dollar of state income tax reduction. In future years, the itemized deduction phase out will be eliminated at the federal level which means the federal tax increase will be 35 cents for every dollar of state income tax reduction.
In a given year, about 40% of Utahns itemize deductions on their federal and state income taxes. If this sounds low, it's because the other 60% includes
- retirees who have paid off their mortgages and whose combined charitable contributions and state income taxes paid are less than the standard deduction
- young taxpayers who do not own homes and do not currently earn a lot of income.
The percent of Utahns that itemize or will itemize deductions during their lifetime is much higher than 40%.