United States: Actions In 2020 May Imperil Illinois Nonresident Taxpayer Positions In 2021

In Short

The Situation: Currently, married taxpayers can file joint federal income tax returns but file separate Illinois income tax returns if one spouse is not a resident of Illinois.

The Development: New legislation would prohibit certain federal joint filers from filing separately in Illinois.

The Impact: High-net-worth families should assess each family member's tax residency and how the legislative change would affect their tax liability.

On June 5, 2019, Illinois Governor J.B. Pritzker signed Senate Bill 687 (S.B. 687) into law as Public Act 101-0008, to take effect on January 1, 2021. S.B. 687 sets the graduated income tax rates that will apply under the Illinois Income Tax Act ("IITA") to taxable years beginning on or after January 1, 2021. The new law, however, "does not take effect at all unless" Illinois voters approve on November 2020 the constitutional amendment allowing graduated rates.

The interaction of S.B. 687 with the current Illinois Department of Revenue regulations on residency will effectively limit the ability of spouses who are residents of different states to assert and preserve the nonresident status of one of the spouses. Taxpayers must begin reviewing their tax position now to prevent inadvertently imperiling their nonresident position in 2021 by their activities in 2020.

Changes to Joint Filing Requirements

Currently, Illinois directs spouses who have different states of residence to file separate Illinois returns even if they file a joint federal return. They may also elect to file a joint return as if both were residents of Illinois. As amended by S.B. 687, section 502(c)(1) of the IITA provides that taxpayers who file a joint federal return for a taxable year ending on or after December 31, 2021, "shall file" a joint Illinois return with joint and several liability. Section 502(c)(3) is an exception to the statutory mandate of section 502(c)(1) by providing that "[i]f either spouse is a resident and the other is a nonresident, they shall file separate returns in this state[.]"

The department's regulations may foreclose separate filing under section 502(c)(3) because events in the preceding taxable year can trigger a presumption of residence that must be overcome by affirmative disclosures and documentation persuasive to the department. If a joint federal return is filed for the taxable year in which nonresident status is asserted, the taxpayer must persuade the department to overcome the presumption. Without sufficient evidence to defeat the presumption, the department can conclude that the federal joint filing compelled the filing of a joint Illinois return under section 502(c)(1) and that filing separate returns under section 502(c)(3) was never an available option. Consequently, the interaction of S.B. 687 and the department's regulations may compel taxpayers to file a separate federal return in order to preserve the ability to file a separate Illinois return.

Immediate Ramifications

The regulations provide that a taxpayer who spends more time in Illinois than in any other state during a tax year preceding the taxable year in which nonresident status will be asserted will be presumed to be an Illinois resident. This presumption of residence is rebuttable; however, such presumptions are rebutted after they have been triggered. In the year the taxpayer asserts nonresident status, the Illinois regulation requires the taxpayer to: (i) make a written disclosure on the Illinois tax return of whether a presumption was triggered by greater presence in Illinois than in another state in the prior year, and (ii) state the reasons why the taxpayer believes "nonresident" is the correct status, together with any evidence "such as certificates or affidavits" to support the position.

If both spouses spend more time in any other state than in Illinois in 2020, the need for disclosure is eliminated because no presumption would be triggered for 2021. Furthermore, if only one spouse will be able to spend more time in at least one other state besides Illinois such that only one spouse does not trigger the presumption, the couple should consider filing separate federal returns in 2021 and plan accordingly. This will ensure that section 501(c)(1) is not triggered if the department is not persuaded that the presumption of residence is overcome by the one spouse's separate return.

Future Tax Rates

Assuming voters approve the graduated rate constitutional amendment, the rates that will apply to individuals, trusts, and estates for taxable years beginning or after January 1, 2021, are as follows:

For separate filers with net income of $750,000 or less:

4.75% of net income not in excess of $10,000

4.90% of net income not in excess of $100,000

4.95% of net income not in excess of $250,000

7.75% of net income not in excess of $350,000

7.85% of net income not in excess of $750,000

For separate filers with net income in excess of $750,000, 7.99% of entire net income.

For joint filers with net income of $1 million or less:

4.75% of net income not in excess of $ 10,000

4.90% of net income not in excess of $100,000

4.95% of net income not in excess of $250,000

7.75% of net income not in excess of $500,000

7.85% of net income not in excess of $1 million

For joint filers with net income in excess of $1 million, 7.99% of entire net income.

The manner in which the graduated individual rates are not uniformly applied to income may support a constitutional challenge to the rate structure by resident and nonresident taxpayers. The stronger position, however, is to avoid the fight altogether by establishing a solid nonresident position for Illinois before the higher rates take effect.

Three Key Takeaways

  1. Married couples who file jointly for federal income tax purposes may no longer be able to file separately for Illinois income tax purposes if the Illinois Constitution is amended to allow graduated rates.
  2. The law limiting filing options would take effect January 1, 2021, but the taxpayers' actions in 2020 could impact their residency status for the 2021 tax year.
  3. High-net-worth families that split time between Illinois and other places should keep meticulous day-count records and seek the advice of counsel experienced in Illinois residency issues.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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