Tax & the Mobile Workforce
Escaping double taxation is a complicated feat for Illinois’ resident and nonresident workers.
Keith Staats, JD
Executive Director, Illinois Chamber Tax Institute
It’s a simple fact of life that many of us live in one state and work in another—and another, and another. Unfortunately, states that impose income taxes on individual incomes all want a portion of our hard-earned wages.
And, of course, there’s little to no consistency across states as to how exactly they intend to impose these taxes on residents and nonresidents. Illinois is no exception.
In our state, issues relating to the taxation of wages are becoming more complex as workers become more mobile. Section 201 of the Illinois Income Tax Act (IITA) imposes a tax on income received “in or as a resident of Illinois.” What this means is that the tax is imposed on compensation paid to an Illinois resident, regardless of whether he or she is employed inside or outside the state. Conversely, the tax is imposed on wages paid to nonresidents who are “paid in this State.” (Please note that this column doesn’t discuss the allocation and apportionment of individuals’ non-wage income. That subject has its own set of complexities.)
Under the IITA, Illinois residents who work in another state—Indiana, for example—end up being taxed by both Illinois and Indiana. Illinois addresses this double taxation by means of IITA Section 601(b)(3), which provides a “foreign” tax credit (foreign means another state, not another country). Simply put, if you’re an Illinois resident who works in another state and that other state taxes your income, Illinois provides a credit against your Illinois tax for the tax you paid in the other state.
IITA Section 601(b)(3) further provides that Illinois law pertaining to nonresident wage taxation must be applied instead of the other state’s law to determine the credit amount. Additionally, Illinois has reciprocal agreements with Iowa, Kentucky, Michigan and Wisconsin that limit a worker’s wage tax exposure in these states to only the state in which he or she resides.
As is the case with all things tax, the actual results under the foreign tax credit are rarely as simple as they seem; in many cases, Illinois residents still end up being double-taxed by Illinois and other states. Here’s why.
IITA Section 302 defines when compensation paid to a nonresident for work in Illinois will be allocated to, and taxable by, Illinois, as follows.
1. Section 302 provides that compensation is paid in Illinois if an individual’s service is performed entirely in Illinois. For example, an Indiana resident is employed by an Illinois company and works in Illinois.
2. Section 302 next provides that compensation is paid in Illinois if the nonresident’s service is performed both within and outside of Illinois, and the service performed outside Illinois is identical to the service performed within Illinois.
3. Section 302 provides that compensation is paid in Illinois if some of the employee’s service is performed within Illinois and either the base of operations or the place from which the service is directed or controlled is within Illinois.
4. Finally, Section 302 states that compensation is paid in Illinois if the individual is resident in Illinois but the base of operations or the place from which the service is directed or controlled is not located in any state in which at least part of the service is performed.
The majority of nonresidents who only occasionally work in Illinois escape being taxed by Illinois. But this isn’t the case for Illinois residents. For example, an Illinois resident is required to work in the State of New York for a week. New York law provides that the Illinois resident is taxable on his wages from the first day he works in New York. The problem is that when the Illinois resident calculates his credit for taxes paid to Illinois, he has to apply the Illinois law. And under Illinois law, if a New York resident were to work in Illinois for a week, Illinois wouldn’t seek to impose income tax on the week of wages. When Illinois law is applied, the Illinois resident in our example is not entitled to a foreign tax credit even though he was required to pay tax to New York, resulting in an unfortunate double taxation.
Representative Natalie Manley, a CPA and member of the Illinois CPA Society, introduced HB 675 during the Spring Session of the Illinois General Assembly to address this exact situation. Rep. Manley’s proposed legislation would change the manner in which nonresidents are taxed by Illinois, and how the foreign tax credit would be calculated. Under the legislation, nonresidents of Illinois would be taxed on their wages for each workday spent in Illinois beginning on the first day worked. With this change, Illinois residents would be eligible for a foreign tax credit for each workday taxed by another state.
Much to Rep. Manley’s dismay, I opposed her legislation on behalf of the Illinois Chamber of Commerce because it would have required an immediate change to the manner in which multistate employers track their employees. In order to implement the legislation, multistate employers would have been required to track the location of their employees on a day-by-day basis and integrate this employee tracking into their payroll withholding systems. A number of Illinois Chamber of Commerce member companies advised that they currently don’t have systems in place to fulfill this requirement, which was confirmed by KPMG’s recent Multistate Nonresident Withholding Survey Report.
All hope is not lost, however. In lieu of moving forward with HB 675, Rep. Manley introduced, and the House adopted, HR 451, which directs the Illinois Chamber of Commerce, Illinois Department of Revenue, Illinois Manufacturers' Association and Illinois Retail Merchants Association to collaborate as a group over the summer and fall to produce a solution to the current double-taxation problem. I’ll keep you posted on how things progress.
Incidentally, as I’m drafting this column, the U.S. Supreme Court has ruled that the State of Maryland’s foreign tax credit violated the U.S. Constitution’s Commerce Clause in Comptroller of the Treasury of Maryland v. Wynne. Based on a quick review of the case, I don’t believe the legality of the Illinois foreign tax credit is affected by this decision.
Finally, Congress is weighing in on this issue again this year. HR 2315 and its counterpart S. 386 in the Senate would create a state income tax threshold for employees who work more than 30 days a year outside the state of their residence—which simplifies requirements and subsequent paperwork for employers and employees.