Simplified Flat Tax would mean savings for most Alabamians (analysis)

Alabama State Senator Bill Hightower introduced the Simplified Flat Tax (SFT) earlier this week, which would lower the state’s income tax to 2.75 percent, but eliminate most of the deductions many Alabamians currently use.

After hearing feedback from several people in different financial situations across the state, Yellowhammer developed the following models to approximate what the SFT could look like in different instances.

First, here are a few important notes. The SFT would apply a tax of 2.75 percent to the federal adjusted gross income (AGI). AGI is calculated by taking all of your income then subtracting the following deductions:

-Educator expenses, which applies to eligible educators for up to $250
-Certain business expenses of reservists, performing artists, and fee-basis government officials
-Health savings account deduction
-Moving expenses
-Deductible part of self-employment tax
-Self-employed SEP, SIMPLE, and qualified plans
-Self-employed health insurance deduction
-Penalty on early withdrawal of savings. This should not be confused with the 10% early distribution penalty that applies to any distributions from retirement account that occur before you reach age 59.5; such amounts are reported as taxable income in the “other taxes” section of your tax return.
-Alimony paid
-Deduction for contributions made to your traditional IRA
-Student loan interest deduction
-Tuition and fees and
-Domestic production activities deduction

The number you get after subtracting those limited deductions is your AGI.

Scenarios where the SFT would decrease the tax burden

– A childless married couple whose AGI is the Alabama median household income of $43,253 which takes only the standard federal deductions currently pays approximately $1,759 in state taxes. Under the SFT they would pay $1,189, a savings of $570, a 32.4 percent decrease.

– A married couple with two children whose AGI is the Alabama median household income of $43,253 who takes only the standard federal deductions currently pays approximately $1,896 in state taxes. Under the SFT they would pay $1,189, a savings of $707, a 37.3 percent decrease.

– A single parent with two children whose AGI is $21,626 (half of the Alabama median household income) who takes only the standard federal deductions currently pays approximately $814 in state taxes. Under the SFT they would pay $595, a savings of $219, a 26.9 percent decrease.

– A single person with no children whose AGI is $21,626 (half of the Alabama median household income) who takes only the standard federal deductions currently pays approximately $781 in state taxes. Under the SFT they would pay $595, a savings of $186, a 23.8 percent decrease.

– A Dual Income With No Kids (DINK) couple whose AGI is $120,000 who only takes the standard federal deductions currently pays approximately $4,788 in state taxes. Under the SFT they would pay $3,300, a savings of $1,488, a 31 percent decrease.

Scenarios where the SFT would increase the tax burden

– A married couple with two children whose AGI is $50,000 but takes an additional $20,000 in itemized federal deductions, such as mortgage interest deductions, health care costs being more than 7.5 percent of income, etc. Such a couple would currently pay $1,300 in state taxes. Under the SFT they would pay $1,375, an increase of $75, a 5.8 percent increase.

– A married couple with two children whose AGI is $100,000 but takes an additional $50,000 in itemized federal deductions, say someone suffered a heart attack or other huge medical expense. Such a couple would currently pay $2,161. Under the SFT they would pay $2,750, an increase of $589, a 27.2 percent increase.

While it would impossible for us to consider the scenario of each of Alabama’s households, we ultimately found that the only people hurt by the SFT would be those who claim a very significant number of deductions currently.

Sen. Hightower has said that his own taxes would go up slightly, but to him it was “well worth it,” to drastically decrease the complexity of the tax code.

He noted in a Yellowhammer Radio interview that Alabama families spend and average of $300 each year to have their state income taxes prepared by an accountant. He believes that expense would be completely eliminated under his plan due to its simplicity.

Take a look at your finances. Would the SFT decrease or increase what you owe in state taxes?

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— Elizabeth BeShears (@LizEBeesh) January 21, 2015