U.S. Businesses Face Higher Federal Tax Bills In 2023 Coupled With State Tax Relief

The new year brings higher federal tax burdens for U.S. businesses. The heftier federal tax bills employers face in 2023 are primarily derived from implementation of the 2022 Inflation Reduction Act (IRA) and the phasing out of temporary provisions in the 2017 Tax Cuts & Jobs Act (TCJA). While the federal government is imposing a larger burden on businesses, state-level tax cuts that recently kicked in are providing countervailing relief in many parts of the country. In fact, 2023 began with business tax reduction of some form taking effect in many states.

Corporate income tax rates fell in Arkansas, Nebraska, New Hampshire, and Pennsylvania on the first day of 2023. The rate cut that took effect in Pennsylvania highlights how corporate tax relief has recently received bipartisan support at the state level. The Keystone State tax cut that took effect on January 1, which was passed by a Republican-controlled legislature and signed into law by Governor Tom Wolf (D), took Pennsylvania’s corporate income tax rate from 9.99% down to 8.99% on the first day of 2023. That tax cut, which was included in Governor Wolf’s final budget passed in 2022, will ultimately bring Pennsylvania’s corporate rate down to 4.99%.

“I’ve been calling for a lower Corporate Net Income Tax rate since I first took office and I’m thrilled that we were able to make this happen in my last budget,” Governor Wolf said after signing the tax cut into law. “This lower rate is a game-changer for business in PA. We’re going to ensure tax fairness, make Pennsylvania a top location for businesses, and bring new, good-paying jobs here for Pennsylvanians.”

That’s not even the most significant corporate income tax cut to be recently enacted by a Democratic governor. The budget signed into law by North Carolina Governor Roy Cooper (D) in November 2021, for example, completely phases out the Tar Heel State’s corporate income tax by the end of 2030. Capital stock tax relief also took effect in North Carolina on January 1, as was also the case in Louisiana, another state where a Democratic Governor and GOP-led legislature have worked together to pass tax relief.

Increasing bipartisan support for corporate tax relief has coincided with cross-ideological recognition and acknowledgment that the burden of corporate taxation is borne by workers and consumers, not just the owners of capital. During the Obama administration, the non-partisan Joint Committee on Taxation and the Congressional Budget Office updated their methodology to begin accounting for the share of corporate taxes that are paid by consumers and workers in addition to shareholders. That change in methodology is why the JCT’s analysis of the IRA released in August 2022 showed that the bill’s corporate tax increases would raise the federal tax burden for taxpayers from all income levels, including on those who make less than $10,000 annually.

Nebraska’s corporate tax rate fell from 7.81% to 5.99% on January 1 and Arkansas’s corporate rate was cut from 5.9% to 5.7%. Arkansas legislators went beyond simple rate reduction by passing legislation in August to ensure that full business capital expensing is still permitted for state tax purposes even as it phases out at the federal level.

Arkansas Senator Ben Gilmore (R), while making the case for full capital expensing, noted that forcing employers to once again deduct capital expenditures over multiple years using convoluted depreciation schedules would diminish the ability of businesses to hire new workers, give existing employees raises, and invest in the expansion of their operations. Without full business expensing, Gilmore said that would mean “Arkansas businesses have fewer resources to invest in equipment and property that will help expand their businesses and create more jobs for Arkansans, putting those businesses in an uncompetitive position.”

The TCJA made full capital expensing for businesses effective for five years and then begins to phase it out over the subsequent five years in order to comply with budget reconciliation restrictions. That deduction is cut by 20% starting in 2023 and every year after until it is fully phased out at the end of 2027. The corporate income tax deduction for research and development costs created by the TCJA went away at the start of 2022.

Where Congress has failed, governors and state legislators have succeeded in making sure businesses can continue to deduct capital expenditures and those related to research and development (R&D). In 2022, Tennessee became the first state where legislation was enacted to ensure that businesses will have a full R&D deduction for state tax purposes.

Oklahoma legislators followed suit and then went a step further in May 2022, enacting legislation to not only extend the R&D deduction for state tax purposes, but also to permanently permit the full year one deduction of capital expenditures when calculating state tax liability. H.B. 3418, which was signed into law by Governor Kevin Stitt (R) on May 26, codified permanent full expensing for capital investments and R&D costs. Many expect more states will follow Oklahoma, Arkansas, and Tennessee’s lead in 2023 by enacting state-level expensing for capital investments and R&D expenditures.

New Hampshire’s Business Profits Tax fell from 7.6 to 7.5% on January 1. The phaseout of the Granite State’s interest and dividends tax also began this month, with the rate dropping from 5% to 4% in 2023. When that tax is completely phased out in 2027, New Hampshire will become the ninth no-income-tax state.

In addition to the tax relief that businesses received through corporate rate cuts, small businesses that file under the individual income tax system, which is most small businesses, benefited from the personal income tax cuts that took effect in 12 states in 2023. Individual income tax cuts took effect at the start of the year in Arizona, Idaho, Indiana, Iowa, Kentucky, Mississippi, Missouri, Nebraska, New Hampshire, New York, North Carolina, and South Carolina. Since most small business owners file under the individual income tax system, these state income tax cuts will translate into increased job-creating and sustaining capacity for millions of small businesses across the country.

Small businesses are poised to get further tax relief in a number of states in 2023. More than half a million sole proprietors, LLCs, partnership and S-Corp owners filed under the individual income tax system in Wisconsin in 2020, the most recent year for which IRS data is available. The Badger State currently levies a top personal income tax rate of 7.65% on individuals, families, and small business owners. Even with the enactment of billions in tax relief over the past decade, Wisconsin is still home to the highest income tax rate in the region, putting the state at a competitive disadvantage. As such, Wisconsin is one of the states where lawmakers are most interested in significantly cutting state income tax rates this year.

Senate Majority Leader Devin LeMahieu (R) has proposed a 3.5% flat tax and some lawmakers would like to go even further. Wisconsin Senate President Chris Kapenga (R) said in December that “if we really want to set ourselves apart and, step up, we say, we’re not going to have an income tax.”

Like Wisconsin, North Carolina is a state with a Democratic governor and a Republican-run state legislature. Just as Republicans are looking to do in the Badger State, leading North Carolina legislators are interested in passing further income tax relief in 2023 and there is reason to believe they’ll be able to do so with bipartisan, veto-proof majorities. North Carolina’s personal income tax rate is already scheduled to phase down to 3.99% by the end of 2026. But with Arizona having moved to a flat 2.5% income tax and many other states chipping away at their income tax rates, many North Carolina lawmakers recognize it’s unwise to rest on their laurels. Next door in the Old Dominion, Governor Glenn Youngkin (R) has proposed cutting Virginia’s corporate tax rate from 6% to 5% and introduced a 10% business income tax deduction for small businesses.

While U.S. businesses are facing a higher federal tax burden thanks to legislation approved by Congress along party line votes last year, governors and state lawmakers have decided to move in the opposite direction, providing tax relief to employers and doing so with bipartisan support. While divided government will likely stamp out further business tax hikes at the federal level for the next two years, expect state lawmakers to continue pursuing business tax relief in 2023, in states with both unified partisan control and divided government.