insight magazine

Tax Decoded | Fall 2017

Taxed in Haste

Assessing the unintended consequences of Illinois’ latest income tax law changes.
Keith Staats, JD Executive Director, Illinois Chamber Tax Institute

In the waning days of the Spring Session, the Illinois General Assembly passed surprising legislation, permanently increasing the state’s individual income tax rate to five percent and the corporate income tax rate to seven percent—that’s right; permanent.

Early versions of the legislation (SB-9) contained temporary tax rate increases. However, one of the last amendments to the bill, a 500 page document, made the move permanent in spite of opposition.

As someone who testified in opposition of the amendment, I tried to raise attention to the unintended consequences of hastily making the income tax rate increases permanent.

The ancillary impact of a permanent income tax increase is something a CPA would recognize immediately—it does more than simply increase the amount of taxes paid. In the case of publicly traded companies, enacting a permanent income tax rate increase triggers significant financial reporting issues.

As explained to me by a CPA member of the Illinois Chamber Tax Institute, companies are required to record deferred tax liabilities for financial reporting purposes under U.S. GAAP. Tax law changes, like this permanent income tax increase, mandate a recalculation of deferred tax liabilities (future tax liabilities recorded on the company’s books).

When a state increases the statutory income tax rate, a company is required to restate existing deferred tax liabilities at the higher rate on its financial statements. Such an increase in deferred tax liability requires companies to recognize an expense to the income statement in the quarter the rate change is enacted. The recognition of these additional expenses will affect a company’s overall financial performance, which could also affect its stock price.

Some states have amended their laws to lessen the impacts major income tax law changes have on company financial statements. Consider Massachusetts’ corporate tax law amendment that mandated combined reporting. All affected companies had to restate deferred tax liabilities.

Massachusetts then enacted legislation to establish a deduction for corporate taxpayers that experienced an increase in a combined group’s net deferred tax liability due to the state’s income tax law change. This offsetting deduction aimed to reduce the potential financial statement impact. The deduction wasn’t effective immediately, but it didn’t need to be to provide financial statement relief.

Massachusetts’ provision originally intended to provide a tax deduction to the affected companies over a seven-year period beginning in 2012, but implementation has been delayed due to fiscal constraints. Current Massachusetts law provides for a deduction over a 30-year period beginning in 2021.

Even though the deduction is not yet available, the presence of the Massachusetts deduction (despite periodic delays in implementing it) has been a benefit to the companies directly impacted by the income tax law change. The continuation of the deduction in some form has allowed the affected companies to avoid the financial statement impact they were originally seeking to mitigate, while delaying and minimizing the revenue impact to the state of Massachusetts. Washington, D.C. and Connecticut have also enacted, but not implemented, similar legislative relief.

As executive director of the Illinois Chamber of Commerce Tax Institute, I’ve been leading the charge to propose an amendment to Section 203 of the Illinois Income Tax Act. The amendment would establish a subtraction modification (deduction), similar to Massachusetts, offsetting the adverse impact of Illinois’ permanent income tax rate increase on the financial statements of publicly traded companies.

The draft legislation proposes making the deduction effective beginning with tax years beginning on or after July 1, 2025 and is spread over a 10-year period. In other words, there would be no revenue impact to the state until tax years beginning on or after July 1, 2025. The Illinois General Assembly would have plenty of opportunity to evaluate the deduction and, if it so chooses, modify it by deferring the date amortization of the deduction begins or lengthening the time period the deduction can be claimed.

In order to provide financial statement relief to affected companies, this issue must be addressed before publicly traded companies are required to complete their third quarter reporting for financial statement purposes. Accordingly, legislative relief must be enacted by Sept. 30, 2017.

By the time you read this column, we’ll know whether our efforts have been successful. But whatever the outcome, the takeaway for policymakers is that there are almost always unintended consequences of legislation—and when legislation is made in haste, there’s no time to fully identify and react to those unintended consequences.

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