Tax Decoded | Spring 2019
Illinois Eyes Corporate Income Again
Legislation circling in Springfield is looking for the “best” way to tax the income of multinational corporations.
Keith Staats, JD
Executive Director, Illinois Chamber Tax Institute
Supporters of proposed Illinois legislation HB 2085 and SB 1115 allege certain corporations
are guilty of stashing vast sums of income outside of the country. In their view, these
multinational businesses are avoiding paying their fair share of income taxes to the
detriment of Illinois and its taxpayers. To “fix” this perceived problem, the proposed
legislation would modify how corporations compute their Illinois income.
The proponents of this legislation are sincere but misguided. The fixes proposed, in my
estimation, are bad policy, largely duplicative of legislation enacted long ago, and are based
on faulty assumptions about the amounts of income on which taxes are being avoided. To
understand both sides of this issue, we need to decode how Illinois laws and regulations
divide the income of multistate and multinational corporations.
Illinois begins with federal taxable income, subject to certain Illinois modifications, as the
starting point for computing a corporation’s Illinois tax liability. Then, the federal taxable
income of a corporation conducting business in multiple states is divided among each of
the states in which business is conducted to derive the income subject to Illinois income
taxation. Illinois, like the majority of states, divides the income of corporations operating in
multiple states by using “formulary apportionment.” In Illinois’ case, this means income is
apportioned to Illinois by comparing sales in Illinois to sales “everywhere.”
Adding another layer of complexity, Illinois, like many other states, doesn’t tax the income
of each related corporation in isolation at the entity level. If a corporation is a member of a
group of related corporations — a “unitary business group” in Illinois Income Tax Act (IITA)
parlance — Illinois treats that group as a single taxpayer. Illinois requires a group of related
corporations that are a unitary business group to file a single combined return — mandatory
These requirements were included in the IITA many years ago to prevent corporations from
avoiding Illinois income taxes by shifting income to related corporations located outside of
Illinois and beyond the reach of Illinois tax law, while shifting deductible expenses to
corporations subject to Illinois income taxation. For example, Nevada-based Corporation
A loans money to Illinois-based Corporation B at a market rate of interest. The interest
expense from this inter-company loan cannot be deducted by Corporation B because
Illinois treats Corporation A and Corporation B as one taxpayer — you can’t deduct the
interest of a loan to yourself.
Now, let’s add another layer of complexity. What happens if you have a group of related
corporations and some of those corporations are located outside of the U.S.? Illinois, like
most other states, is what is known as a “water’s edge” state. Illinois only includes foreign-based
corporations in the unitary business group and combined Illinois income tax return
if the foreign-based corporations have a significant U.S. presence. The unitary business group definition requires what is known as
an 80/20 test to make this determination.
To be a member of a unitary business
group, a corporation must have at least 20
percent of its property and payroll located
within the U.S.
This 80/20 rule provides a tax planning
opportunity. Take the loan example above
but put Corporation A in Bermuda instead.
If Corporation A is in Bermuda and doesn’t
meet the 80/20 test, Corporation A can’t
be included in the unitary business group
or combined income tax return and the
interest expense to Corporation B won’t be
eliminated. You could do the same thing
with intangible property such as patents
and trademarks. But Illinois shut down this
tax planning opportunity more than 10
years ago when the IITA was amended to
require companies to add back these types
of federal deductions when calculating
income subject to Illinois income taxation.
Back to the currently proposed legislation.
Its proponents assert that their bills are
necessary to shut down the tax evasion
tactics of corporations in so-called tax
havens (Bermuda et al.). Apparently, the
proponents don’t understand the IITA well
enough to be aware of the addback
provisions that already put an end to such
tax avoidance schemes. It isn’t necessary
to switch to worldwide combination to
combat income shifting because Illinois has
already addressed the issue.
My fear is HB 2085 and SB 1115 will radically
change the IITA, adding unnecessary
complexity while reducing the likelihood of
international investment in the state. A
substantial increase in state revenues is
simply unrealistic given our current tax
laws. What’s more, the issues with
perceived tax havens were further
mitigated at the national level with 2017’s
federal tax reform legislation, the details of
which go well beyond the space limitations
of this column.
These proposed bills would essentially
change the IITA back to utilizing the flawed
way of apportioning the income of
multinational businesses on a worldwide
combination basis that was thoroughly
analyzed and addressed by a U.S. Treasury
Department working group that consisted
of federal and state government and
business representatives and resulted in
Illinois and most other states adopting
water’s-edge legislation in 1984.
Should Illinois’ legislators really be trying to
reinstitute tax complications we cured
more than 30 years ago?