The uncertain future of Illinois income taxes

Where we stand today: Income taxes

Individual, Trusts, and Estates: Illinois maintains a flat income tax rate of 4.95% for individuals, trusts, and estates, regardless of how much or how little income is earned.

Businesses: Illinois C corporations are subject to an income tax rate of 7%. S corporations and partnerships ("pass-through entities") are not subject to Illinois income taxes but are subject to replacement taxes as described below.

Where we stand today: Replacement taxes

Replacement taxes, originally imposed to replace revenue that was lost when local governments were no longer able to collect personal property taxes, are taxes collected by the state of Illinois in addition to income taxes. These taxes are imposed on the net income of C corporations, S corporations, partnerships, trusts, and public entities.

C corporations are subject to a 2.5% replacement tax rate, while partnerships, trusts, and S corporations are subject to a 1.5% replacement tax rate.

Income tax changes in Gov. Pritzker's proposal

In an effort to bring in more money to help improve the state's bleak financial outlook, Governor Pritzker has proposed a graduated income tax structure, also known as the "Fair Tax," which would raise income tax rates for the Illinois' wealthiest individuals as well as corporations.

The proposed tiers for individual (both single and joint filers) income taxes are as follows:

Rate/Income:

4.75%/$0-10,000

4.90%/$10,001-100,000

4.95%/$100,001-250,000

7.75%/$250,001-$500,000

7.85%/$500,001-$1,000,000

7.95%*/$1,000,001-plus *

*Taxpayers with income in excess of $1 million are required to pay 7.95% on all of their taxable income

The governor has also proposed raising the corporate income tax rate from 7% to 7.95%. In combination with replacement taxes, the total tax rate for corporations would be 10.45%, making it the third highest corporate income tax rate in the nation behind Iowa (12%) and New Jersey (11.5%).

Under Gov. Pritzker's proposed tiered state income tax proposal, pass-through business income could be taxed as high as 9.45% (partnership replacement tax of 1.5% and new top individual income tax rate of 7.95%).

Other changes in the Pritzker proposal

In addition to changes to the individual and corporate tax rates, Gov. Pritzker has proposed increasing the property tax credit from 5% to 6% (only applies to single filers with income up to $250,000 and joint filers with income up to $500,000). He has also proposed creating a per-child tax credit of up to $100 per child for individuals earning less than $80,000 and $100,000 for joint filers.

Senate Bill 687

Senate bill 687, which made it through both the House and Senate in late May, was sent to the Governor's desk for signature on June 4. Like the governor's proposal, this bill also puts forth a graduated income tax structure, however, at slightly higher rates. The rate structure for single and joint filers earning less than $250,000 would be the same as what was proposed by the governor. However, it would begin to differ when income levels exceed $250,000. Notably, single filers earning more than $750,000 and joint filers earning more than $1,000,000 would be taxed at a top rate of 7.99%.

In addition to modifying individual income tax rates over $250,000, the corporate tax rate would be raised to 7.99%.

Finally, the bill follows the Governor's proposal with regard to the child tax credit and property tax credit.

Process required for this to become law

Currently, the Illinois constitution mandates a flat-rate income tax structure. In order to get a tiered income tax structure into law, an amendment to the Illinois constitution must be approved to allow for graduated income tax rates. As of today, this amendment has passed both the Illinois House and Senate and will be put before voters in the November 2020 election. In order for the amendment to be approved by voters, either three-fifths, or 60% of people voting on the amendment must approve it, or, a simple majority (more than 50%) of all voters must approve it, including those who skip the question.

Assuming that the voters approve the proposed amendment to the constitution, the Governor has vowed to sign Senate Bill 687 into law which would be effective Jan. 1, 2021.

Viewpoints of Republicans and Democrats

Republicans worry that allowing for a tiered income tax structure will make the opportunity for raising tax rates in the future much easier, especially on the middle class. Further, they argue that tax hikes must be coupled with comprehensive pension reform, because, absent any reform, the likelihood for future tax hikes to help pay off pension obligations seems probable. Moody's estimates that Illinois has approximately $232 billion in unfunded liabilities (https://www.illinoispolicy.org/without-pension-reform-progressive-income-tax-amendment-guarantees-tax-hikes-on-illinois-middle-class/).

Many also believe that these increases are highly punitive on small and medium-sized businesses. They feel that it will push companies and potential employees away from Illinois into nearby, lower-tax states and make Illinois less competitive. The Tax Foundation estimates that Illinois's competitive ranking would drop from 36th to 48th overall (https://taxfoundation.org/illinois-fair-tax/).

Alternatively, Democrats argue that the proposed tax structure will provide relief for the majority of Illinois taxpayers. They estimate that the tiered tax structure would result in the same or lower taxes for 97% of Illinoisans and only the "rich", or those making in excess of $250,000, will pay more. Many find it unfair that the states' poorest and most wealthy individuals are required to pay taxes at the same percentage rate. Finally, many Democrats also see this plan as a sound way to address the Illinois budget crisis.

Conclusion

It is unclear whether or not the proposed amendment will be approved by voters in the 2020 election. However, it's important to understand how the potential changes could affect you and your business and what you could be doing today to mitigate any additional tax liabilities down the road. If you'd like to learn more about how these proposed changes might impact you, please reach out to a member of the Weiss & Company team.

• Jason Field is a Certified Public Accountant and Manager with Weiss & Company LLP. He focuses his practice primarily on tax matters, regularly advising clients on individual and business tax compliance and planning from a federal and state perspective.