Tax Decoded | Summer 2016
Ball of Confusion
Determining what constitutes a fair share of corporate income is anything but simple.
Keith Staats, JD
Executive Director, Illinois Chamber Tax Institute
In my last column, we jumped into how the Illinois Income Tax Act (“IITA”) is imposed on the privilege of earning or receiving income “in or as a resident of this state.
Still, the question of when income is earned “in” Illinois is, in many situations, one of the more vexing issues, very technical and often subtly nuanced. This is particularly true in the case of corporations that are, by law, defined as nonresidents.
What’s more, every state has its own rules, so anything I say here may not apply elsewhere. Individuals, partnerships, trusts and estates also deal with some of these same issues, and have their own unique scenarios. But I’d imagine only true tax geeks like me would enjoy diving deeper into that.
A corporation located in Illinois with no presence in any other state—“nexus” in technical tax terms—generally will be subject to Illinois taxation on 100 percent of its income. Of course, the taxation of a corporation with nexus in multiple states becomes more complex.
The characterization of income as “business,” which the IITA defines in detail, or “non-business,” defined as all income that is not business income, is important in determining Illinois taxation. As a general rule, the IITA provides that non-business income is allocated to a corporation’s state of commercial domicile. Business income is divided, or “apportioned,” between the various states in which a corporation has nexus.
In Illinois (see IITA Section 304), this apportionment of business income is accomplished by multiplying the corporation’s income by a percentage that is derived from comparing its sales in Illinois to its total sales. For example, a corporation with total sales of $100K where $20K are attributable to Illinois would be taxed by Illinois on 20 percent of its income.
While that seems easy enough, Illinois law also provides that certain types of companies engaged in certain types of business require certain types of apportionment formula. Insurance companies, for example, apportion income bas-ed on premiums written, and transportation companies apportion income based on miles traveled in Illinois versus total miles everywhere.
In other words, it’s complicated. But getting back to sourcing a corporation’s sales, we first have to determine the nature of the sale. Is it a sale of real property or tangible personal property, a sale of an intangible item, or a lease of real property or tangible personal property, etc.?
In the case of sales of tangible personal property, they’re apportioned to Illinois if the property is delivered or shipped to a purchaser (other than the US government) within Illinois. In the case of intangible items, IITA Section 304 has rules for the apportionment of receipts from the licensing of patents, copyrights, trademarks and similar items based on the utilization of such items in Illinois.
The determination of when receipts from the provision of telecommunications and broadcasting services are attributable to Illinois is subject to very detailed provisions in IITA Section 304.
Receipts from leases of real property and tangible personal property are attributable to Illinois if the property is located in Illinois. The sourcing of receipts from leases of mobile property, such as vehicles, is a bit more complex, being attributable to Illinois to the extent that the property is used in Illinois.
The treatment of sales of services is another tricky area that continues to be a source of confusion and controversy. Illinois law enacted in 2008 provides that sales of services are attributable to Illinois if the services are “received” in Illinois. This seemingly simple and straightforward provision is anything but, as evidenced by the detailed explanation in Section 304 of how this determination is made. Indeed, the Illinois Department of Revenue (IDOR) has been working on regulations on this subject since 2008, and still hasn’t reached agreement on a rule.
IITA Section 304 provides that gross receipts from the provision of services to a corporation, partnership or trust may only be attributed to a state where that recipient of services has a fixed place of business. If the state where the customer receives the services is not “readily determinable” or is a state where the customer doesn’t have a fixed place of business, the services will be deemed to have been received at the location of the office from which they were ordered. If the ordering office can’t be determined, the services will be deemed to have been received at the office of the customer to which the services are billed.
However, if the services provider is not taxable in the state in which the services are received, the sale is excluded from the apportionment formula. In other words, the law acknowledges that it’s sometimes impossible to determine the sourcing of services. This “throw-out” rule has been criticized by taxpayers and tax practitioners who contend that taking such receipts completely out of the apportionment formula improperly skews the calculations.
As you can see, the sourcing of income earned by a corporation conducting business in multiple states is anything but simple. Good faith disagreements between taxpayers and the IDOR can have profound tax implications. And given the rather murky nature of the laws governing a number of these issues, it’s easy for such disagreements to happen.