The new tax reform law – the Tax Cuts and Jobs Act – has been extensively reported in a variety of media outlets. Most discussions focus on the reduction in individual and corporate tax rates, the availability of deductions and modifications to tax statutes related to the Affordable Care Act. But the new law's reach extends far beyond those issues. This client alert summarizes how the Tax Cut and Jobs Act may affect local governments throughout Illinois.
The SALT Caps
The new law caps the federal income tax deductions for payments of state and local property, income, and sales tax (known as SALT). The new maximum deductions are $10,000 for joint filers and $5,000 for individual filers.
In Illinois, there is no local government income tax, but there is a statewide income tax and, of course, local property taxes. The sum of these taxes in many jurisdictions will far exceed the $10,000 maximum SALT deduction. Some analysts worry that the new caps will increase pressure on local governments to hold property tax levies flat, because many property owners will not be able to write off their current SALT taxes, much less any increases. "This represents a fundamental erosion of the federal-state-local balance in taxation and hamstrings counties' ability to deliver essential services," said Matthew Chase, Executive Director of the National Association of Counties, in a press release.1
Many property owners in Illinois rushed to prepay their 2017 property tax bills before the new limitation took effect on Jan. 1. It remains to be seen whether, as the grip of the new law tightens in 2018 and beyond, taxpayers affected by the deduction caps will press local government officials to mitigate the impact by reducing property and sales tax rates.
Advance Refunding Bonds
The new law broadly reduces tax rates – at least in the short-term – for individuals and corporations alike. And, of course, with a reduction in the tax rate comes an anticipated reduction in tax revenues. An unfortunate consequence of those potential state and federal revenues shortfalls is a near-total elimination of tax-exempt status for governmental advance refunding bonds.
Local governments are no strangers to issuing bonds as a means of raising revenue. Government-issued bonds are an attractive investment in part because interest earned on the bond funds is not taxable. And local governments are also accustomed to refinancing their bonds if market conditions are favorable. But these refinancing bonds, known as advance refunding bonds, are no longer exempt from taxation unless they are issued within the 90-day period prior to the call date for the older bonds.
Governments that issue new debt are now forced to accept the financial terms of their bonds for the life of those bonds, and thus they cannot practically take advantage of falling interest rates to refinance. In those cases, local taxpayers are forced to shoulder the full load of interest payments because their local governments cannot take advantage of lower interest rates. And the governments themselves will be less nimble in recalibrating their financial and capital plans to maximize the benefit of debt financing and to pay for infrastructural needs. Those governments either will have to issue taxable debt, or forego the benefits of bond refinancing, or identify new revenue streams to make up the difference.
There is a bit of positive news for local governments that host professional sports teams or that hope to lure a professional team in the future. The new tax law preserves an important exemption for bonds that support construction of stadiums and related facilities. Prior to 1986, the Internal Revenue Code contained express permission for tax-exempt financing for sports facilities. In that year, the express permission was deleted by Congress, but the Code did not outlaw tax-exempt financing for stadiums.
There were early indications in the legislative process for the tax reform bill that this exemption loophole would be closed: President Donald Trump criticized the National Football League's "massive tax breaks" on Twitter, and the bill initially approved by the U.S. House of Representatives outlawed the exemption. But the U.S. Senate preserved the authority for tax-exempt stadium financing and the final Conference Report approved by both legislative chambers did as well.
With any comprehensive tax code changes, there will likely be other unanticipated issues caused by the rewrite. Congress often enacts legislative correction bills to fix mistakes and unintended consequences of new provisions.