United States: Illinois Enacts Budget Increasing Income Tax Rates, Eliminating Unitary Non-Combination Rule

On July 6, 2017, the Illinois House of Representatives followed the Senate and voted to override Governor Bruce Rauner's veto of S.B. 9, enacting the state's FY 2017-2018 budget after two years without a spending plan.1 Effective July 1, 2017, the legislation substantially increases the corporate and personal income tax rates. Other major corporate income tax amendments include elimination of the unitary business non-combination rule, reinstatement of the research and development credit, and decoupling from the federal domestic production activities deduction (DPAD). Personal income tax amendments include an increase of certain credit amounts, but an elimination of the standard exemption and certain credits for high-income individuals. Also, the sales tax exemption for graphic arts machinery equipment is reinstated. Finally, the legislation enacts the State Tax Lien Registration Act and the Revised Uniform Unclaimed Property Act.

Corporation Income Tax

Tax Rate Increase

Effective July 1, 2017, the legislation increases the corporate income tax rate from 5.25 percent to 7 percent for all corporations except S corporations.2 In addition, the previous sunset date of January 1, 2025 is removed, making the tax increase permanent.3 The legislation includes guidance for allocating income for a mid-year rate change. Taxpayers can choose between two allocation methods: (1) an apportionment method that divides the full year net income based on the ratio of the number of days each rate was in effect; or (2) a specific accounting method that divides income and deductions between the two periods based on when they were generated.4

Unitary Business Non-Combination Rule Eliminated

The legislation eliminates the non-combination rule for unitary businesses for tax years ending on or after December 31, 2017.5 Prior to amendment, certain industries, such as transportation companies, financial service organizations and insurance companies, were required to exclude members from the unitary business group that used different apportionment methods.6

Definition of United States Expanded for Unitary Business Groups

For tax years ending on or after December 31, 2017, the legislation expands the definition of "United States" for unitary business groups to include the outer continental shelf.7 Specifically, the law is amended to require unitary businesses to include members earning income in any area over which the U.S. has asserted jurisdiction or claimed exclusive rights with respect to the exploration for or exploitation of natural resources. The definition will continue to exclude members operating in any U.S. territory or possession.8

Research and Development Tax Credit Reinstated

The Research and Development Tax Credit is reinstated and extended through tax years ending prior to January 1, 2022 (previously, January 1, 2016).9 The legislation specifically makes the extension of the credit retroactive to the tax year beginning on January 1, 2016 so that the credit is continuously available.10

Federal DPAD Decoupled

The legislation decouples Illinois tax law from the DPAD provided by Internal Revenue Code (IRC) Section 199 for tax years ending on or after December 31, 2017.11 Under previous state law, in addition to corporations, partners and shareholders who were allowed to take the federal DPAD could take the deduction when calculating their Illinois net income as well.12

Personal Income Tax

Tax Rate Increase

Effective July 1, 2017, the legislation increases the personal income tax rate from 3.75 percent to 4.95 percent.13 This applies to individuals, trusts and estates. In addition, the previous sunset date of January 1, 2025 is removed, making the tax increase permanent.14

K-12 Education Expense Credit Limitation Increase

The legislation increases the amount of the Education Expense Credit from $500 for tax years ending prior to December 31, 2017 to $750 for tax years ending on or after December 31, 2017.15 In addition, the law implements a means test that eliminates the credit for taxpayers with adjusted gross income for the taxable year exceeding $500,000 in the case of spouses filing a joint federal return or $250,000 for all other taxpayers.16

Standard Exemption and Residential Property Tax Credit Eliminated for High-Income Individuals

The standard exemption allowance17 and the residential real property tax credit on property taxes paid on a principal residence are amended to add an income test for whether the exemption and credit may be taken.18 For tax years beginning on or after January 1, 2017, the standard exemption and residential real property tax credit are not available for taxpayers with adjusted gross income over $500,000 in the case of spouses filing a joint federal return or $250,000 for all other returns.

Earned Income Tax Credit Increase

The legislation increases the earned income tax credit over two years.19 For tax years beginning on or after January 1, 2017, the credit is increased from 10 percent to 14 percent of the federal earned income tax credit.20 For tax years beginning on or after January 1, 2018, the credit is increased from 14 percent to 18 percent of the federal earned income tax credit.21

Instructional Materials and Supplies Credit Enacted

For tax years beginning on or after January 1, 2017, the legislation creates an Instructional Materials and Supplies Credit.22 The credit is calculated as the amount paid or $250, whichever is less, for instructional materials and supplies with respect to classroom-based instruction in a qualified school. The credit cannot be carried back, may not reduce the taxpayer's liability to less than zero and may be carried forward five years. In order to be eligible, the taxpayer must be a teacher, instructor, counselor, principal or aide in a qualified school for at least 900 hours during a school year. A qualified school is defined as a public school or non-public school located in Illinois.

Sales and Use Tax

Extended Discount for Ethanol and Biodiesel Fuels, Accelerated Sunset for Gasohol

The legislation extends the sunset date for the majority blended ethanol fuel, biodiesel and biodiesel blends exemption from December 31, 2018 to December 31, 2023.23 Also, the legislation eliminates the 20 percent exemption on sales of gasohol as of July 1, 2017.24 The previous sunset date was December 31, 2018.25

Exemption for Graphic Arts Machinery and Equipment Reinstated

Effective July 1, 2017, the exemption for graphic arts machinery and equipment is reinstated under the manufacturing exemption.26 Under prior law, graphic arts machinery and equipment was exempted by a separate carve-out exemption that expired on August 30, 2014. Now, the same rules governing the manufacturing machinery and equipment exemption will apply to graphic arts purchases.27

State Tax Lien Registry

Effective January 1, 2018, the State Tax Lien Registration Act requires the Illinois Department of Revenue to establish and maintain a public database that will be known as the State Tax Lien Registry.28 The purpose of the act is to create a centralized system for filing notices of tax liens that are in favor of or enforced by the Department.29 The act is limited to tax liens in real and personal property of persons against whom the Department has liens for unpaid final tax liabilities administered by the Department.30 The current system requires liens to be filed in each of Illinois' 102 applicable counties.

Revised Uniform Unclaimed Property Act

Effective January 1, 2018, the legislation creates the Revised Uniform Unclaimed Property Act (RUUPA),31 replacing the current Uniform Disposition of Unclaimed Property Act.32 RUUPA updates the definition of property to include previously excluded items such as virtual currency and stored value cards and adds presumption of abandonment periods.33 Also, RUUPA eliminates the "business to business" exemption, thus requiring that businesses report to the State Treasurer any unclaimed property which is owned by another business entity.34

Commentary

Following a contentious two-year period during which there was no state budget, the Illinois legislature overrode Governor Rauner's veto and enacted a budget that includes permanent income tax increases. Governor Rauner was amenable to an income tax rate increase under the following conditions: (i) the tax rate increase was temporary and only lasted for four years; (ii) a temporary four-year freeze on property taxes; (iii) term limits for elected officials; and (vi) pension reform. By overriding the governor's veto, the legislature enacted a permanent income tax increase without the associated reform measures that were sought by the governor.

It appears that this legislation will fall short of addressing many of the serious fiscal issues facing Illinois. The state has a reported $14 billion dollar of unpaid bills that is sure to increase as invoices for more recent purchases of services and tangible personal property make their way to the state controller. Additionally, this legislation does little if anything to address the estimated $125 billion of unfunded pension obligations. Because the legislation does not correct the structural issues that Governor Rauner says are holding Illinois back, he asserts that it will only be a matter of time before Illinois taxpayers see another tax increase.

In addition to making the total Illinois corporate income tax rate of 9.5 percent (7 percent income tax and 2.5 percent replacement tax) one of the highest rates in the country, the fact that the tax increase is effective in the middle of the calendar year creates complexities. For example, both calendar year individuals and corporations required to make estimated tax payments will need to pay tax at the higher rate for income received on or after July 1, 2017. Thus, taxpayers will essentially have portions of their income taxed at different rates. In the recently released Informational Bulletin FY 2018-02, the Department notes that it will provide additional guidance in January 2018.

Fiscal year taxpayers also will be impacted for income received on or after July 1, 2017. Informational Bulletin FY 2018-02 provides guidance for taxpayers filing a 2016 Illinois income tax return as a fiscal-year, short-year, or 52/53 week filer, and the taxpayer's tax year ends on or after July 1, 2017. Since two tax rates will apply to the taxpayer's tax year, Illinois will allow one of two methods to determine tax due:

  • Method 1 - Apportionment method (blended rate) - dividing a taxpayer's net income received based on the total number of days in one accounting period in equal ratio to the total number of days in the second accounting period.
  • Method 2 - Specific accounting method - allows a taxpayer to treat net income or loss and modifications as though they were received in two different taxable years (prior to July 1, 2017, and on or after July 1, 2017) and calculates the income tax due at the appropriate rate for each period. This election is irrevocable.35

Taxpayers also will have to incorporate this change into their tax provision for both their current and deferred rate.

The repeal of the non-combination rule may simplify some companies' filings related to their Illinois unitary business group (UBG). Prior to the repeal, if a taxpayer had a transportation company, insurance company or financial institution in its UBG, it was not allowed to file only one return. Instead, this type of company was required to file a separate return. Out-of-state companies would often overlook this requirement due to Illinois' unique rules, which would lead to scrutiny under audit, particularly if filing one return was beneficial from an Illinois tax perspective.

While simplification will be welcome from the standpoint of compliance requirements, it currently is not known how the change will be reflected mechanically on the tax return. In Illinois, transportation companies, insurance companies and financial institutions are required to use special apportionment methodologies.36 No guidance has been provided on how these companies should be combined with other members of the UBG. Another level of complexity relates to differences in sourcing receipts to the extent any of the special entities are considered to be captive.

For example, in the transportation industry, assume a major carrier has two subsidiaries in its structure: Trucking Company (TC) with Freight Broker (FB). Assume TC is a captive company that works exclusively for FB (the ultimate customer contracts with FB and FB hires TC). When sourcing receipts for apportionment purposes, TC would look to transportation rules, while FB would look to general sourcing rules governing the sale of services necessitating the use of market-based sourcing. However, when consideration is given for intercompany transactions, the mechanics of the tax return would eliminate TC's receipts, leaving FB's receipts in the apportionment factor calculation. While the entity as a whole may be considered a trucking company, the receipts that remain after consolidation are sourced based on market-based sourcing. In this instance, it would seem appropriate to apply a miles-based formula to these receipts versus market-based sourcing because the identity of the entity is a trucking company.

In contrast, consider a scenario where a non-transportation company (for example, a retail company) has a trucking company subsidiary that is a captive company working exclusively for the retail company. Before consolidation, assume the retail operations comprise 80 percent of the company's total receipts and the trucking operations represent the other 20 percent. When the receipts are consolidated, the trucking company's receipts would be eliminated. Given that the identity of the entity under this scenario is a retail company, presumably the receipts would be sourced as a sale of tangible personal property.

While states are split on DPAD conformity, Illinois now joins the non-conformity list. It should be noted that in the current discussion involving potential federal tax reform, DPAD has been discussed as one of the deductions that will be eliminated. Thus, it is possible this federal deduction will not be available in the future.

The reinstatement of the Research and Development Credit through years ending prior to January 1, 2022 will now allow taxpayers to utilize the credit on their 2016 returns. Any taxpayer already filing its 2016 return prior to the reinstatement will need to amend its tax return to claim the credit.

Footnotes

1 P.A. 100-0022 (S.B. 9), Laws 2017. The Senate had previously voted to override the governor's veto on July 4, 2017. For further information on the legislation, see Informational Bulletin FY 2018-01 and Informational Bulletin FY 2018-02, Illinois Department of Revenue, July 2017.

2 35 ILL. COMP. STAT. 5/201(b)(13). Combined with the 2.5 percent replacement tax that remains in effect, the total tax for corporations is 9.5 percent.

3 35 ILL. COMP. STAT. 5/201(b)(14).

4 35 ILL. COMP. STAT. 5/202.5. For additional information, see Informational Bulletin FY 2018-02, Illinois Department of Revenue, July 2017.

5 35 ILL. COMP. STAT. 5/1501(a)(27)(B). 

6 Id.

7 Id.

8 Id.

9 35 ILL. COMP. STAT. 5/201(k).

10 Id. It is the legislature's intent that this credit applies continuously for all tax years ending on or after December 31, 2004 and ending prior to January 1, 2022.

11 35 ILL. COMP. STAT. 5/203(a)(2)(D-24), (b)(2)(E-17), (c)(2)(G-16), (d)(2)(D-11). The DPAD amount must be added back to income.

12 Informational Bulletin FY 2006-07, Illinois Department of Revenue, Feb. 2006.

13 35 ILL. COMP. STAT. 5/201(b)(5.3). Similar to corporations, individual taxpayers have the option of accounting for the mid-year rate change using the apportionment method (blended rate) or specific accounting method. See Informational Bulletin FY 2018-02, Illinois Department of Revenue, July 2017.

14 35 ILL. COMP. STAT. 5/201(b)(5.4). 

15 35 ILL. COMP. STAT. 5/201(m).

16 Id.

17 35 ILL. COMP. STAT. 5/204(g).

18 35 ILL. COMP. STAT. 5/208.

19 35 ILL. COMP. STAT. 5/212(a).

20 Id.

21 Id.

22 35 ILL. COMP. STAT. 5/225; Informational Bulletin FY 2018-01, Illinois Department of Revenue, July 2017. 

23 35 ILL. COMP. STAT. 105/3-10; 110/3-10; 115/3-10; 120/2-10.

24 Id.

25 Id.

26 35 ILL. COMP. STAT. 105/3-5(6), (18); 105/3-50; 110/2; 110/3-5(5); 115/2; 115/3-5(5); 120/2-5(4), (14); 120/2-45.

27 See ILL. ADMIN. CODE tit. 86 § 130.330.

28 S.B. 9, Art. 1, to be codified as 35 ILL. COMP. STAT. 750.

29 S.B. 9, § 1-5(a).

30 S.B. 9, § 1-5(b).

31 S.B. 9, Art. 15, to be codified as 765 ILL. COMP. STAT. 1026.

32 S.B. 9, § 17-5, repealing 765 ILL. COMP. STAT. 1025, effective Jan. 1, 2018.

33 S.B. 9, §§ 15-102(24); 15-201; 15-206.

34 For the exemption under the prior act, see 765 ILL. COMP. STAT. 1025/2a(b). 

35 Informational Bulletin FY 2018-02, Illinois Department of Revenue, July 2017. Note that the Department recommends that taxpayers use Method 1. 

36 35 ILL. COMP. STAT. 5/304(b), (c), (d). 

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