The Iowa Department of Revenue recently announced three tax revisions, effective for the January 1 through December 31, 2018 calendar tax year. Along with the revised interest rate it will charge taxpayers on delinquent taxes and make payable to taxpayers on their overdue refunds, the IDR also released the 2018 tax brackets and standard deduction amounts.
The annual interest rate for 2018 will be increased to 6 percent with a monthly rate of 0.5 percent. This is the first change to the interest rate since 2010, where the rate has held at 5 percent.
The interest rate used by the IDR is based on the U.S. prime rate, which closely correlates to the fed funds rate set by the Federal Reserve. The fed funds rate is the rate at which banks borrow and lend money to each other. It serves as the benchmark for which short-term credit is often based on, such as credit cards, lines of credit and short-term personal and business loans. As a general rule, the prime rate is equal to the fed funds rate plus 3 percent. The IDR uses the average prime rate from the preceding 12 months, which was 3.91 percent. It then adds 2 percent, rounded to the nearest whole percent. Thus, the IDR’s new interest rate will be 6 percent.
So, what exactly is driving the increase in the IDR’s interest rate?
In response to the 2007-2009 recession, the Fed dropped the fed funds rate to near zero. The goal was to stimulate spending to help boost a then-flailing U.S. economy. However, the economy has since returned to a moderate pace of economic growth. As part of its mandate, the Fed has decided to start raising the fed funds rate as a measure to prevent excessive inflation. By raising interest rates, it gently taps the breaks on economic growth to prevent the economy from overheating, which would send prices skyrocketing. The Fed has implemented three 0.25 percent rate hikes since December 2016 and is set for a further hike this December. Also, the Fed is projecting three more rate hikes each in 2018 and 2019. As the fed funds rate increases, so does the prime rate off of which the IDR bases its own interest rate.
For singles and married filing separately, the 2018 standard deduction was raised from $2,000 to $2,030. For married filing jointly, the deduction was raised from $4,920 to $5,000.
The IDR also released its revisions for the 2018 tax brackets. The tax rates remain the same, but the income levels for the nine individual tax brackets were inflation-adjusted, in a process known as indexing. Indexing helps prevent “bracket creep," where taxpayers are pushed into a higher tax bracket, and a higher tax rate, simply from their salary keeping pace with inflation. Ideally, indexing maintains a taxpayer’s purchasing power, as wages and the costs for goods and services rise at the near-same pace with no additional tax burden.
The IDR releases its new interest rate and adjustments to the tax brackets and standard deduction each October for the following tax year.