Illinois Corporate Income Tax Basics- Base Income04/24/2018
Now that we have provided a primer on procedural issues at Illinois, Chicago, and Cook County, it’s time to jump into the fun stuff! Illinois has a relatively high corporate income tax rate compared to most states (a combined 9.5%), coming in at the fourth highest rate in the United States. In 2019, the Governor’s budget anticipates that corporate and personal income taxes will constitute more than 50% of Illinois’ general funds revenues, generating over $20 billion. Consequently, Illinois’ administration of its corporate income tax generates a significant amount of litigation compared to many other states. While calculating Illinois base income is generally straightforward, certain aspects are rather complex, particularly with respect to foreign income and dividend income from certain types of investment companies.
Illinois Statutory Modifications
Illinois base income begins with the U.S. Form 1120, Line 30, or equivalent, amount. See Form IL-1120 Instructions. Illinois Income Tax Act section 203 then provides the addition and subtraction modifications to be applied to the Federal starting point.
Some of the most significant addition modifications to Illinois base income relate to interest received from regulated investment companies, net operating losses, and payments to foreign entities. All amounts of interest paid or accrued to taxpayers and all distributions received from regulated investment companies must be added to Illinois base income. 35 ILCS 5/203(b)(2)(A). Additionally, any net operating loss deduction taken in arriving at taxable income other than a net operating loss carried forward from a taxable year ending prior to December 31, 1986 must be added back. 35 ILCS 5/203(b)(2) (D) (Illinois provides its own way of calculating the Illinois net loss, 35 ILCS 5/203(e)). For taxable years 2001 and thereafter, taxpayers must also add back the bonus depreciation deduction taken under IRC 168. 35 ILCS 5/203(b)(2) (E-10).
For taxable years ending on or after December 31, 2008, interest payments to a person who would be a member of the same unitary business group but for the fact that the person is a foreign entity (more than 80% of its activity is outside the United States), must also be added back to Illinois base income. 35 ILCS 5/203(b)(2) (E-12). However, this modification does not apply where the foreign payee is subject in a foreign country or state to a tax on or measured by net income with respect to that interest. Id. at (E-12)(i). A similar add back is required where insurance premium expenses and costs are made to a member of the same unitary group that is excluded from the group because it is required to file a separate Illinois return as an insurance company. 35 ILCS 5/203(b)(2) (E-14).
Also notable is how Illinois treats Real Estate Investment Trust (REIT) dividends. For taxable years beginning after December 31, 2008, any deduction taken for dividends paid by a captive real estate investment trust must be added back. 35 ILCS 5/203(b)(2) (E-15). This inverts the manner in which the Federal government taxes REITs, which taxes the dividends at the recipient, not the payor level.
Many of the Illinois subtraction modifications correspond to the addition modifications. For instance, exempt interest dividends paid to shareholders by a regulated investment company may be deducted from Illinois base income. 35 ILCS 5/203(b)(2) (H). However, the most notable subtraction modification is contained in 35 ILCS 5/203(b)(2)(O). This modification provides that for periods after December 31, 1992, taxpayers may deduct a percentage equal to that allowed under IRC 243(a)(1) (a percentage that may be either 50% or 100% depending on whether the dividends are “qualifying dividends” for Federal purposes) for dividends received from a corporation that is not created or organized under the laws of the United States or any political subdivision thereof, including dividends received or deemed received or paid or deemed paid under IRC sections 951 through 965. For taxable years ending on or after December 31, 2008, dividends received from a captive REIT should also be deducted. Dividends included in taxable income, including for taxable years on or after December 31, 1988, dividends received or deemed received or paid or deemed paid under IRC sections 951 through 964 should also be deducted. This section effectively requires taxpayers to deduct all Federal Subpart F income and REIT dividend income from Illinois base income.
Specifically with respect to REITs, these modifications reflect the fact that in Illinois, unlike on the Federal consolidated return, REITs are to be included in the Illinois combined group. Consequently, for tax years after December 31, 2008, these modifications effectively eliminate the dividend payment entirely.
Constitutional Limitations on Illinois Base Income
The Illinois Income Tax Act also provides that taxpayers shall deduct all amounts included in Federal income which are exempt from taxation by Illinois either by reason of its statutes or Constitution or by reason of the Constitution, treaties or statutes of the United States. 35 ILCS 5/203(b)(2)(J). Non-unitary income, such as certain types of investment income, is therefore statutorily excludable from Illinois base income, irrespective of whether the income is generated by a member of the combined Illinois group.
Prior to 2002, when a taxpayer sold its stock or substantially all of its assets for a particular business, Illinois generally treated the gain as nonbusiness income. Blessing/White, Inc. v. Zehnder, 329 Ill App 32 714 (2002). At the time, the perception was that businesses are not generally in the business of selling off entire operations, so the gain should not be includible in Illinois business income. Now, however, Illinois requires a more rigorous analysis to determine whether the asset that generated a particular gain was unitary with the taxpayer’s Illinois business. See MeadWestvaco Corp. v. Illinois Department of Revenue, 553 U.S. 16 (2008). This is a heavily factual inquiry and it may often be difficult to prove whether a particular class of assets or stock is unitary with the Illinois taxpayer. Indeed, even in MeadWestvaco, the United States Supreme Court remanded the case back to Illinois to make a determination as to whether the division sold in that case was in fact unitary with the Illinois operations. In such cases, as will be discussed in a later post on apportionment, the Illinois Department of Revenue may be amenable to alternative apportionment to allow for factor relief. Otherwise, instances of a large gain on the sale of a business may dramatically inflate Illinois base income but be excluded entirely from the apportionment factor, thus resulting in a tax liability that does not accurately reflect the company’s business operations in Illinois.
While many parts of Illinois tax compliance may be very complicated, calculating Illinois base income is generally straightforward. The most notable deviations from Federal taxable income relate to investment companies, such as Regulated Investment Companies and REITs, and foreign income. Generally speaking, Illinois inverts the federal treatment of investment companies and excludes Subpart F income. With recent Federal tax reform, it is certainly possible that Illinois will calibrate its modifications, particularly with respect to foreign income.