The Vermont Legislature has gone home after spending an unprecedented windfall of about half a billion dollars in federal Covid relief funds. But by refusing to advance a seemingly arcane tax reform proposal, lawmakers left a smaller pot of money on the table.
The proposal relates to when Republicans in Congress changed the federal tax code in late 2017. Prior to that, taxpayers could deduct an unlimited amount of state and local taxes from their federal income taxes, a deduction called SALT. . After the change, they were limited to deducting $10,000 a year — disproportionately impacting Democratic states with high income and property taxes, like Vermont.
“The SALT cap was meant to be a punitive measure against blue states,” said Lake Champlain House lobbyist Austin Davis.
Since then, 24 states, including New York and Massachusetts, have adopted a workaround to allow residents to recoup at least some of the federal tax deductions they lost.
This workaround is called a transmission entity tax.
Intermediaries are businesses that are not taxed at the corporate tax rate, but instead are “passed through” on a business owner’s personal income tax. In other words, the owners and co-owners of these businesses pay tax on their business income as part of their personal income tax.
These owners include self-employed, partnerships, and S corporations. (S corporations are like partnerships, but they cannot have more than 100 shareholders and they cannot be owned by another legal entity. An S corporation may have one or more shareholders.)
Danforth Pewter in Middlebury is one of tens of thousands of Vermont businesses that could have benefited from the tax relief.
“You take a company like Danforth Pewter which is a flow-through entity, and generally we pass all of our income through to our shareholders and they pay all of the federal and state taxes on that,” CEO Bram Kleppner said.
But if Vermont changed its law to allow intermediary companies such as Danforth Pewter to pay local and state taxes to their owners, the income the owners would earn from the business would already be eliminated. They would only pay federal corporate income tax less local and state taxes.
As for the state of Vermont, the owners would have already paid their state and local taxes on their business, so they would owe nothing more except for a small proposed change in the law. Vermont would not give a full tax credit to business owners. This would give them a 90% tax credit on their personal income tax for the tax paid by the business, and tax them on the remaining 10%.
So while business owners would pay less federal income tax, they would pay slightly more Vermont income tax. But they would pay less tax overall.
It is unclear how much additional revenue the state would collect.
Legislative Economist Graham Campbell told lawmakers earlier this month that his office believed the state would collect more revenue if it passed the tax, but could not say how much more.
Speaking to a panel of lawmakers finalizing S.11, the Labor and Economic Development Bill, Campbell said Vermont business owners could save up to $20 million by federal taxes per year under the proposal.
At that same May 9 hearing, Vermont Tax Commissioner Craig Bolio agreed that his office could not calculate how much the state would collect in additional taxes, but he guaranteed it would be positive.
“It seems like every state targeted to be hurt by this has adopted this workaround,” said Sen. Alison Clarkson, D-Windsor.
But the proposal met with little enthusiasm from the outgoing chair of the House Ways and Means Committee, Rep. Janet Ancel, D-Calais.
“Nobody on (Ways and Means) expressed much interest in pursuing it, so we kind of put it aside,” Ancel told the conference committee on S.11. “I don’t feel like it’s really the right time to take that step. I really believe that we should not adopt our tax policy in response to what the federal authorities are doing.
One of the conference committee co-chairs, Rep. Michael Marcotte, D-Coventry, chairman of the House Committee on Commerce and Economic Development, was also skeptical.
“One thing I can see, rightly or wrongly, is that it helps high-income people in the state,” Rep. Michael Marcotte said. “It comes down to, the whole issue across the country is the rich getting richer and the poor getting poorer. People earning $300,000, $400,000, $500,000, $600,000, $1 million a year will now get another tax cut.
Proponents of the tax workaround argue that it would also have saved federal small business income tax.
“The failure of the Legislative Assembly to adopt language that would have saved Vermont small business owners millions in federal taxes is certainly disconcerting,” said Lake Champlain Chamber Speaker Catherine Davis. “Why keep making small businesses in our state send money to DC that could otherwise be put to work in Vermont? I can’t think of a good reason.”
Davis, the House lobbyist, said the organization would continue to push for tax change in the next legislative session.
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