Illinois’ Corporate Income Tax: Never-Ending Complexity

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

The Illinois Income Tax Act, as is the case with virtually all other state income taxes, piggybacks off the federal income tax. In the case of corporations, the determination of income subject to Illinois income taxation begins with federal taxable income.

In the early years of the act, Illinois’ tax base mirrored the federal tax base. Those who drafted the legislation believed it would keep the Illinois tax so simple that there’d be no need for the Illinois Department of Revenue (IDOR) to hire state income tax auditors. Obviously, we now know better—the Illinois income tax is anything but simple. Instead, it’s full of complexities caused by decoupling from federal tax treatment that, in my opinion, costs taxpayers and IDOR money and time.

DECOUPLING STRATEGIES

Over the years, Illinois has decoupled from various provisions of the federal tax base. In some instances, such as addbacks for related party expenses, Illinois decoupled from the federal tax base to address what IDOR and the Illinois General Assembly perceived to be improper “tax planning” that resulted in an understatement of income “properly” attributable to Illinois.

In other instances, such as the River Edge Redevelopment Zone Act, decoupling was motivated by a desire to encourage redevelopment of certain areas of the state by providing a special tax benefit. In other instances, such as decoupling from federal net operating losses, the decoupling was an effort to address complexities triggered by other corporate income tax changes and, in later years, to increase Illinois income tax revenues. For example, Illinois decoupled from federal net operating losses in 1986. At the time of decoupling, one purpose was to address complications that ensued when Illinois law adopted the “unitary business group” definition in 1982. In later years, loss carryback provisions were eliminated, and the carryforward period was shortened in an attempt to generate additional state tax revenues. However, in late 2021, the pendulum swung back the other way when the loss carryforward period was extended.

Unfortunately, these decoupling practices can sometimes be short-sighted, particularly when they introduce unnecessary compliance costs and complexity in preparing returns and creating and maintaining documentation for Illinois income tax audits. The best example of this is the decoupling from federal special depreciation.

FEDERAL SPECIAL DEPRECIATION

In simple terms, depreciation is an annual tax deduction that allows a taxpayer to recover the cost or other basis of certain property over the time the property is used. Think of it as an allowance for the wear and tear, deterioration, or obsolescence of a property.

For property acquired after Sept. 27, 2018, the Tax Cuts and Jobs Act authorized special depreciation allowances of up to 100% in the year a property was placed in service. Allowing special depreciation, including 100% expensing, has the effect of reducing federal taxable income in the year in which the special depreciation is claimed and has been used at the federal level as a method to spur investment in capital assets. It also has the effect of increasing federal taxable income in subsequent years since the depreciation deductions have been taken in whole or in part of the earliest year. Many states, including Illinois, didn’t like this result—hence, they decoupled from federal special depreciation.

The most recent Illinois legislation was the second time Illinois attempted to decouple from federal depreciation rules. After 9/11, Illinois enacted flawed legislation that was designed to decouple from federal special depreciation enacted by Congress to spur investment. This first attempt to decouple from federal special depreciation worked if the federal deduction was less than 100% in the year the property was placed in service. However, because of a flaw in the drafting of the legislation, Illinois law allowed 100% expensing in any year in which the federal special depreciation authorized 100% expensing (This drafting mistake was corrected by legislation a couple of years ago).

Currently, Illinois law requires a taxpayer to add back any special federal depreciation and then replace it with an Illinois depreciation deduction. As a result, Illinois taxpayers are required to set up a separate depreciation tracking system for Illinois income tax purposes in addition to their federal depreciation tracking.

I can attest from my time in private practice—and subsequent discussions with Illinois taxpayers and practitioners—that virtually every Illinois corporate income tax audit by IDOR results in an inordinate amount of time addressing Illinois depreciation addition and subtraction modification issues with IDOR auditors.

In the end, the amounts depreciated by taxpayers under Illinois and federal laws should be the same. The effect on a taxpayer’s income tax liabilities should also be the same. The only things that should change are the years in which the depreciation deductions are taken and the years in which taxes are paid. Therefore, the time and resources expended by taxpayers and IDOR on decoding this topic makes Illinois’ income tax anything but simple—and arguably more complex than necessary.

Related Content:

• ‘Uncapping’ Illinois’ Property Tax Extension Limitation Law: A simple property tax cap? It’s more complex than that.
• Decoding Illinois’ Major Sales Tax Exemptions: While all sales of tangible personal property are presumed taxable, Illinois law does offer various exemptions. Here’s a rundown of the state’s major sales tax exemptions.