Summary and analysis of income tax reform in LB 754
Nebraska’s Revenue Committee advanced an amendment to LB 754 out of committee on a 7-1 vote last week, bringing Gov. Pillen’s income tax reform plan to the full Unicameral for debate.
The bill is a tour de force of income tax reforms. The individual and corporate income taxes are both overhauled by the bill, with top rates slashed, the tax structure flattened, and the tax base trimmed. These changes would significantly enhance Nebraska’s competitiveness and impact nearly every Nebraskan either directly or indirectly. The reforms are so broad that even some non-Nebraskans would be directly impacted.
Income tax rate reforms
LB 754 contains several different tax reforms. Yet the headline reforms are undoubtedly the changes to Nebraska’s income tax rates.
Individual income tax
Under current law, Nebraska’s progressive income tax rate structure maxes out with a top rate of 6.64% upon income beyond $29,000 for individuals, and beyond $58,000 for joint filers.
Nebraska income tax rates and brackets, 2023
Also under current law, Nebraska’s top rate is scheduled to gradually phase down to 5.84% on January 1, 2027 as a result of LB 873, which was enacted in 2022.
LB 754 would collapse Nebraska’s top two brackets into a 3.99% top rate by January 1, 2027. Nebraska’s top rate in 2027 would be nearly one-third lower under LB 754 than the currently-scheduled top rate of 5.84%.
Nebraska income tax rates and brackets under LB 754, tax year 2027
Nebraska’s income tax structure would remain progressive under LB 754. In addition, Nebraska’s large standard deduction and $157 credit for each household member make the income tax even more progressive than the rate structure would appear.
Corporate income tax
In addition, LB 754 cuts, consolidates, and flattens Nebraska’s corporate income tax. The current corporate tax is 5.58% on the first $100,000 of corporate income, and 7.25% on income beyond $100,000. Also under current law, Nebraska’s top corporate rate is scheduled to go down to 5.84% by 2027.
LB 754 would consolidate Nebraska’s two-rate system into one low, flat rate of 3.99% by 2027.
In sum, the rate reforms in LB 754 will deliver substantial tax relief and dramatically improve Nebraska’s rate competitiveness in an increasingly competitive state tax environment.
Individual Income tax base reform
LB 754 contains several meaningful changes to the base of the individual income tax, which is the portion of individual income that is subject to taxation. The individual income tax base is narrowed by growing deductions, credits, and exemptions, and expanded by trimming deductions, credits, and exemptions.
Child care tax credit
The first change to the tax base is the creation of a $15 million child care tax credit for families. This new program creates a refundable income tax credit for parents. Eligibility is based upon the household income level. A credit of $2,000 per child is made available for households with income below $75,000, and a credit of $1,000 is made available for households with income between $75,000-$150,000. A refundable credit means the taxpayer can receive the credit even if it exceeds the taxpayer’s total tax liability.
The program also creates a $10 million non-refundable tax credit for businesses and individuals that contribute to a child care provider. The credit is worth 100% of a contribution made to a child care facility in a federally-designated opportunity zone, and 75% of a contribution made to a child care facility not in a federally-designated opportunity zone. This non-refundable credit is capped at $100,000 per taxpayer per year.
Both of these tax credits could become over-subscribed, in which case the bill specifies the credits will be granted by order of application.
Social Security and other retirement exemption
An exemption for Social Security benefits was created in 2022’s LB 873. This tax exemption is accelerated by one year in LB 754. Beginning January 1, 2024, 100% of federal social security benefits will be exempt from state income taxation. This change eliminates the taxation of Social Security benefits a year earlier than previously scheduled. Individuals are also able to exempt their federal retirement annuity benefits from state taxation.
Expanded itemization for property taxes
Nebraska taxpayers are eligible to reduce their taxable income by taking a state standard deduction, or by itemizing their deductions on their state return. Taxpayers who itemize are eligible to import their federal deductions to their state return, minus the $10,000 federal deduction for state and local taxes paid.
LB 754 allows Nebraskans who itemize to take a state deduction for the portion of their property taxes that exceeds the $10,000 federal deduction for state and local taxes paid.
For example, if a Nebraskan pays $10,000 in state income taxes and $8,000 in local property taxes, he can only itemize $10,000 for state and local taxes on the federal return. That effectively allows the $10,000 state income taxes to be deducted against the federal return, yet the $8,000 in local property taxes exceed the allowed federal SALT cap.
LB 754 will allow Nebraskans to deduct against their state returns the portion of their property taxes that they could not deduct on their federal return. In this example, that would mean all $8,000 in property taxes could be deducted on the state return because it all exceeded the $10,000 federal SALT cap.
Remote work tax policy
LB 754 makes several corrections to how Nebraska taxes remote workers and the businesses that employ them. These reforms were adopted from LB 173 (analyzed here).
First, LB 754 creates a 30-day filing and withholding threshold for remote workers and the businesses that employ them. In short, remote workers temporarily staying in Nebraska won’t owe taxes to Nebraska until they exceed 30 days in the state, nor will their employers need to withhold state taxes until the 30-day threshold is exceeded. This is a smart change to reduce the burden of tax compliance and to attract more remote workers to Nebraska.
In addition, LB 754 will no longer subject non-Nebraskans to Nebraska’s income tax if they no longer commute into Nebraska for work. Nebraska is currently one of only four states that taxes individuals for income earned from Nebraska businesses if they live within commuting distance to Nebraska, even if they don’t actually work in Nebraska.
Business income tax base reform
LB 754 creates permanent full expensing for businesses that make capital investments in Nebraska. Full expensing allows businesses that spend on research and experimentation or on machinery and equipment to deduct those full expenses against their taxable income in the year in which the expenses are incurred.
Per dollar of foregone revenue, full expensing is arguably the most pro-growth measure a state can add to its tax code. Without full expensing, Nebraska businesses would have to amortize the deductions for their investment costs over a 5-20 year depreciation schedule. Amortization prevents businesses from achieving full cost recovery, particularly when high inflation erodes the value of deductions taken in future years.
Nebraska conformed with the federal tax code on full expensing through the end of 2022. Federal conformity brought Nebraska the benefits of full expensing as they existed in the federal tax code from 2018-2022. But now those benefits are phasing out of the federal code, so it is wise for lawmakers to make full expensing permanent in the state code.
If enacted, LB 754 would be the most substantial tax reform Nebraska has achieved in decades. Rates would be slashed and the tax base would be trimmed. The proposed rate reductions would make Nebraska far more competitive. Some of the reforms to reduce the income tax base are sound tax policy, and others will have broad political appeal.