PROVIDENCE — When Governor Carcieri recently signed into law a bill to implement the biggest overhaul of the state’s personal income tax system in nearly 40 years, the emphasis was mainly on a historic reduction in the top tax rate.
But Rhode Island’s individual income tax system does not have just one rate — there are five of them. And what happened to those other rates will have a far-reaching impact on thousands of taxpayers when the new system takes effect on Jan. 1, 2011.
Changes in those other rates will, for example, result in a tax cut for some middle-income taxpayers — even though they will lose out on a key tax benefit involving their deductions.
Government leaders have stressed the reduction in the top rate for good reason: At 9.9 percent, it is sixth highest in the nation, said former state revenue director Gary S. Sasse. With a new top rate of 5.99 percent, starting in January 2011, Rhode Island will rank about 25th among the states, he said.
The new top rate will help to make Rhode Island more competitive, from a tax standpoint, with other states — which, in turn, should help to attract and retain businesses — and promote job creation, said John C. Simmons, executive director of the Rhode Island Public Expenditure Council (RIPEC), a business-backed group that monitors the state’s finances.
But the top tax rate is only part of the story. To understand the rest, recall how the state tax is calculated: After subtracting various deductions and exemptions, you come to a figure known as Rhode Island taxable income. Then you essentially sort that income into baskets (also known as brackets). Each basket has its own tax rate.
If you are a low-income taxpayer, there is only one basket to bother with, the one with the lowest tax rate, 3.75 percent. But if you are a middle-income or higher-income taxpayer, you face higher tax rates. For example, if you are married and file a joint tax return, only the first $56,800 of your Rhode Island taxable income is taxed at 3.75 percent. The next chunk of your income is taxed at 7 percent, and other portions at 7.75 percent, 9 percent and 9.9 percent.
The new system still has multiple rates, but fewer of them, with a far different impact. For example, under the new system, whether you are married or single:
• The first $55,000 of your Rhode Island taxable income will be taxed at 3.75 percent.
• The next chunk of your income will be taxed at 4.75 percent, instead of 7 percent. (The 4.75 percent rate will apply to income between $55,000 and $125,000.)
• The rest of your income will be taxed at a maximum rate of 5.99 percent (instead of progressively higher rates of 7.75 percent, 9 percent and 9.9 percent).
Because of this radical change in the tax structure, some middle-income taxpayers will pay less, starting next year, said Patricia A. Thompson, vice chair of the American Institute of Certified Public Accountants’ national tax executive committee.
That is true even though the new law will no longer allow taxpayers to make a separate list of their deductions, a process known as itemizing. Instead, all taxpayers will have to claim the lump-sum deduction, known as the standard deduction, said Thompson, who is also tax partner at Piccerelli Gilstein & Co. LLP, a CPA firm in Providence.
For some people, the combination of lower tax rates overall and the higher standard deduction amounts next year will more than make up for the tax benefit they would have received had they still been able to itemize deductions, said Grafton H. “Cap” Willey IV, co-chair of the Rhode Island chapter of the Smaller Business Association of New England, a trade group for small businesses.
A key factor is that, for many middle-income taxpayers, the highest tax rate will be 4.75 percent, instead of 7 percent, on a portion of their income, said Paul L. Dion, chief of the state Office of Revenue Analysis. “There’s no question that going down to 4.75, from 7 or 7.75 percent, is huge,” and will favorably impact some taxpayers, Dion said.
Not everyone will see a tax savings. According to new calculations issued last week by the state Office of Revenue Analysis, and based on 497,283 resident tax returns:
• About 60 percent — or 297,763 returns — will see a tax decrease, averaging about $242 apiece.
• About 21 percent — or 103,434 returns — will see no change.
• About 19 percent — or 96,086 returns — will see a tax increase, averaging about $528 apiece.
Who might pay more and who might pay less under the new system?
If you normally claim the standard deduction, you will probably pay less, because the standard deduction amounts will be higher under the new system. Overall, about 55 percent of taxpayers claim the standard deduction, according to state Division of Taxation figures.
Those who have “big houses with large mortgages and high property taxes” will probably pay more in tax, said Willey, the managing director in charge of the Newport office of CBIZ Tofias, an accounting firm. For them, the lower tax rates and new standard deduction amount will not be able to make up for the tax benefit of itemizing.
If you are a high-income taxpayer and planned to use the optional flat-tax method next year to take advantage of its 5.5-percent rate, you may wind up paying more in tax. That is partly because there will be no more flat tax option after Dec. 31, and the regular system’s top rate will be a bit higher than next year’s flat-tax rate would have been.
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