The Complex Reality of Illinois’ Income Tax

Keith Staats, JD Special Counsel, Duane Morris LLP
Deciphering Today's State & Federal Tax Law

The Illinois Income Tax Act (IITA) has become complex for many taxpayers—but that wasn’t always the case. The IITA was simple when first enacted in 1969. It piggybacked off the federal Internal Revenue Code (IRC), with few variations. Today, the IITA simply uses the IRC as a starting point in determining net income subject to Illinois income taxation.

There are three primary reasons for the current complexity: 1) legislation decoupling the IITA from various IRC provisions; 2) a plethora of Illinois credits and deductions; and 3) various additions.

Generally speaking, decoupling has been used in response to changes to the federal IRC that would reduce Illinois income taxes if allowed to flow through to the IITA; Illinois credits and deductions are used to incentivize new businesses to come to Illinois, promote expansion by existing Illinois businesses, and influence taxpayer behaviors; and additions are used to “correct” what state policymakers determine to be lower Illinois taxes resulting from the application of the IRC at the state level.

Unfortunately, there’s ongoing incongruity between legislation aimed at preserving Illinois’ tax base by decoupling from federal IRC changes and legislation aimed at providing credits and subtractions that erode it. In the end, these conflicting practices often leave existing Illinois taxpayers feeling the effects of the former, while new Illinois taxpayers receive the benefits of the latter.

Decoupling the IITA From IRC Provisions

As I predicted in my last column, the Illinois General Assembly decoupled again from the IRC during its fall veto session via passage of Senate Bill (SB) 1911. The tax omnibus bill allows Illinois to decouple from a portion of the federal One Big Beautiful Bill Act (H.R. 1)—specifically, IRC Section 168(n) related to qualified production deductions for manufacturing. Under Section 168(n), businesses may elect to deduct 100% of new production property in the year in which the property is placed in service rather than deducting a portion of the cost of the property each year over the life of the property as laid out in the IRC.

The rationale for decoupling is that the state can’t afford the loss of revenue from the current budget year that began on July 1. While it’s true that IRC Section 168(n) could create a loss of state tax dollars for the current fiscal year, that isn’t true in the long term. In the long term, the state should collect as much tax revenue as it would if Section 168(n) hadn’t been enacted. That’s because Section 168(n) changes when the cost of qualified production property may be deducted. For instance, if a taxpayer elects the 100% deduction in year one, taxes are reduced in year one but are increased over the remainder of useful life of the production property for which the 100% deduction was claimed. However, state revenues are viewed in Springfield on a year-to-year basis instead of the long term.

All in all, SB 1911 continues an almost 25-year history of Illinois decoupling from federal legislation, making Illinois tax compliance much more complex. As a result, taxpayers must keep one set of books for purposes of depreciation for federal purposes and another for Illinois.

Importantly, there will likely be other provisions of H.R. 1 that Illinois legislators will consider decoupling from during the upcoming spring 2026 legislative session—so stay tuned for more complexity!

Credits and Deductions

As I’ve stated earlier, the IITA has an ever-expanding list of Illinois-specific credits and deductions. The credits and deductions favor specific types of taxpayers and are designed to incentivize companies to relocate to Illinois or expand in Illinois, among other things. However, in my estimation, this focus tends to leave behind existing Illinois taxpayers.

Three of the most expensive credits (in terms of the impact on the state budget) that illustrate this effect include:

1. Illinois Research and Development (R&D) Credit: This credit is tied to the definitions in the federal R&D credit. On the surface, it would seem that the credit should benefit all Illinois businesses that engage in R&D in the state—except it doesn’t. The Illinois R&D credit is a credit for increasing qualified research in Illinois. In other words, companies that engage in extensive amounts of qualified R&D only receive credit for increases in the amount of R&D year over year based on a statutory formula. As a result, the credit is skewed toward companies locating or relocating their research facilities to Illinois, not for companies that are merely maintaining a steady level of R&D in Illinois.
2. Economic Development for a Growing Economy (EDGE) Tax Credit: The EDGE credit is designed to attract new businesses to Illinois or encourage the expansion of existing Illinois businesses by providing income tax credits for capital investment and job creation.
3. Film Production Services Tax Credit: This credit is designed to entice film production in the state by providing credits to offset Illinois income taxes that would otherwise make Illinois an unattractive location in comparison to states with lower tax rates. The film credit has gone through multiple expansions since being enacted around 20 years ago. Most recently, SB 1911 added additional enhancements to the credit.

The Illinois Comptroller’s Tax Expenditure Report for fiscal year (FY) 2023 (the most recent year for which data is currently available) further illustrates how substantial these tax credits are. According to the report, the film credit reduced corporate income tax receipts by $156 million, the EDGE credit reduced receipts by $140 million, and the R&D credit reduced receipts by $106 million. In all, these three credits account for reduced receipts of $402 million, or more than 5% of the total corporate income tax receipts for FY 2023 of $7.32 billion.

Additions

Lastly, the IITA is made even more complicated by the numerous additions—such as modifications and decoupling provisions—that emerge. For example, there are currently 18 possible additions to federal taxable income that may be required by IITA Section 203(b).

The overwhelming majority of these additions result from decoupling from the IRC. For example:

• Section 203(b)(2)(D): Results from Illinois decoupling from federal net operating loss deductions.
• Section 203(b)(2)(e-10): Results from Illinois decoupling from federal bonus depreciation.
• Sections 203(b)(2)(e-12 through e-15): Result from Illinois requiring taxpayers to add back certain federal deductions attributable to payments made to foreign companies.

Suffice it to say, the history of the IITA reveals an ongoing pattern of decoupling from the IRC alongside introducing additions to federal adjusted gross income (individuals) and federal taxable income (corporations) in instances where federal legislation would erode the Illinois tax base. At the same time, Illinois legislators of both parties continue to erode the Illinois tax base by providing more and more credits and deductions skewed toward enticing new businesses to relocate to Illinois. As such, existing Illinois businesses ultimately get left behind in the complexity—they receive the tax increases, not the tax decreases.

Related Content:

• Decoding the One Big Beautiful Bill’s Impact on State Income Taxes: Uncertainty around the new federal tax legislation looms over Illinois income taxes as federal conformity hangs in the balance.
• The Cost of Tariffs? More Complex Illinois Sales Taxes: According to a recent IDOR ruling, tariffs aren’t excluded from the Illinois tax base.