Decoding Decoupling: The Facts Behind Pritzker’s Proposal

Keith Staats, JD Executive Director, Illinois Chamber Tax Institute
Deciphering Today's State & Federal Tax Law

During the January lame duck session of the Illinois General Assembly, Gov. J.B. Pritzker pushed a proposal to decouple Illinois from certain provisions of the federal Internal Revenue Code (IRC) enacted in March 2020 within the Coronavirus Aid, Relief, and Economic Security (CARES) Act. He suffered a rare legislative defeat but has already expressed his intention to again seek decoupling during the spring legislative session.

The drafters of the 1969 Illinois Income Tax Act—wisely, in my opinion—determined that the most efficient way in which to adopt an Illinois income tax was to base the state tax on the federal IRC. Because of this, the terminology of the Illinois Income Tax Act is identical to the federal IRC and other federal income taxation statutes unless specified.

Since 1969, there has been some decoupling from the federal IRC. In the 1980s, the state decoupled from federal taxation of retirement income. The state also decoupled from federal net operating losses for corporations, trusts, estates, and partnerships—though not from the federal treatment of individual net operating losses. In the 1990s, the state decoupled from federal bonus depreciation rules.

The result of these choices has been an increase in complexity. The Illinois Department of Revenue (IDOR) would likely contend that decoupling, at least in the case of net operating losses, brought more revenue to the state by limiting the total amount of state net operating losses claimed. In the case of depreciation, the argument is less clear: There is no net revenue gain in the long term as the revenue is spread out over different tax years. Instead of taking a larger deduction in earlier years and a smaller deduction in later years as is the case under federal bonus depreciation, the state deduction is spread over the useful life of the item.

The added complexity has led to disputes between taxpayers and IDOR. In the case of net operating losses, it has involved disputes over the tracking and documentation of losses. In the case of depreciation, there are similar disputes over documentation and many audit issues involving whether and how the depreciation addition and subtraction modifications have been properly calculated. These disputes lead to a waste of time and resources on both sides.

Gov. Pritzker’s recent proposal involves decoupling from the temporarily modified net operating loss law as well as from the temporary suspension of the excess business loss limitations for non-corporate taxpayers, both granted under the CARES Act. The federal net operating loss changes would only affect individual taxpayers because, as noted, Illinois decoupled from federal net operating losses for corporations, trusts, estates, and partnerships many years ago. Under the CARES Act, net operating losses generated in 2018, 2019, and 2020 may be carried back for five years, and the federal limitation on the use of net operating losses was suspended for tax years beginning before Jan. 1, 2021. To my understanding, the rationale for this CARES Act provision was to allow taxpayers to file amended returns and obtain refunds that would provide much-needed cash to those adversely affected by the COVID-19 pandemic.

The CARES Act also suspended the limitation on non-corporate taxpayers’ use of excess business losses until 2021. Under the Tax Cut and Jobs Act of 2017, beginning in 2018 business losses in excess of $250,000 ($500,000 in the case of a joint return) were disallowed for non-corporate taxpayers.

Gov. Pritzker’s rationale for this decoupling effort was the purported fiscal impact of the federal changes. Given the state’s adverse budget situation, he likely feels that the state can’t afford to give out these additional refunds. It is unclear to me why he waited until January 2021 to attempt to decouple from these federal provisions because the state impact of the federal changes was evident at the time the CARES Act passed in March 2020.

If I am correctly reading Gov. Pritzker’s legislative proposal, the decoupling would result in individual taxpayers never receiving the benefit of the net operating losses. The legislation, if enacted, would just pretend the CARES Act changes never occurred. Because there is no separate Illinois individual net operating loss statute like there is for corporations, the losses of individuals would not merely be deferred to a different time but would be lost forever. This is particularly harsh because the individuals affected by this change are likely the individual business owners most severely affected by the economic impact of COVID-19.

If the governor is successful in his renewed attempts to decouple from the federal provisions, it would be retroactive and therefore even more complicated. If legislation is enacted by the end of the spring legislative session on May 31, many taxpayers will have already submitted their 2020 tax returns as well as amended returns for the prior tax years affected by the federal net operating loss changes.

It is unknown to me what IDOR has been doing, if anything, with refund claims that have been received to date. We will have to wait and see whether the legislation will attempt to claw back any refunds issued prior to its enactment and whether the department would attempt to assess interest on any such amounts that would be recouped.

Decoupling from the federal IRC can be complicated. To the extent it is done, it should be done sparingly, because it increases the complexity of the Illinois Income Tax Act while offering few benefits.

Author’s Note: This column includes my personal observations and does not necessarily represent the views of the Illinois CPA Society.