March 14, 2013
Governor Pat Quinn has proposed eliminating several corporate tax incentives to help pay down the State’s backlog of unpaid bills that is expected to total $7.5 billion at the end of the current fiscal year.
The Governor’s proposal would eliminate three rules that allow corporations to reduce tax liabilities and would increase State corporate income tax revenues by an estimated $445 million annually. The funds generated from the changes would then be deposited in a new special account and used only to pay for bills more than 90 days overdue.
The proposed tax policy changes, which were announced during the Governor’s FY2014 budget address, are included in Amendment 1 to Senate Bill 1159. The legislation proposes eliminating the corporate tax deduction allowed for Foreign Dividends; repealing the Non-Combination Rule; and decoupling from the federal Domestic Production Activities deduction.
The majority of the revenue attributed to the proposal would come from the taxation of dividends paid to corporations that are based in Illinois but receive income from foreign subsidiaries. According to a summary produced by the Governor’s Office of Management and Budget (GOMB), State revenues would increase by $320 million due to this change. Currently under the federal Internal Revenue Code, which Illinois uses as the basis for its corporate tax code, dividends paid from one domestic arm of a company to another are exempt from taxation. However, like many other states according to the GOMB analysis, Illinois extends this exemption to foreign dividends as well. SB1159 would eliminate the latter exemption, increasing the taxable income of Illinois companies by any profits earned overseas.
The second largest increase in State revenue from the proposed tax changes would be an estimated $100 million if the State decoupled from the federal Domestic Production Activities deduction. Under this rule, companies that are involved in certain production activities are eligible to reduce their taxable income related to those operations by 9.0%. The federal rule is intended to encourage domestic manufacturing and employment, but Illinois also provides the incentive even though the activities might take place outside the State. According to GOMB, 22 other states have already decoupled from this rule or have never been tied to the federal provision.
The last change would remove an exemption to the Illinois Income Tax Act that allows certain businesses to avoid the State law requiring related companies to file a single tax return. This rule requires that revenue transfers and costs between the entities be omitted to prevent corporations from reducing their tax liability. Currently the Non-Combination Rule applies to financial organizations, insurance companies and transportation companies. According to GOMB, repealing the rule would increase State revenues by $25 million.
Business groups have already expressed opposition to the changes, claiming the policy changes would be a tax increase for the corporations that take advantage of the tax incentives. Opponents argue that the increases would harm the State’s financial recovery and hamper recent employment gains.
In his budget address, Governor Quinn said the corporate tax changes would only be temporary, suggesting that they would be reinstated once the State’s backlog of bills is paid down. However, the language in the bill does not include sunset provisions or any other horizon for reinstating the rules. Reinstatement of the benefits in the near future appears unlikely considering the magnitude of the unpaid bills compared to the expected revenues. The pending loss of revenues expected when the State’s current temporary income tax increases partially rolls back in FY2015, as discussed here, would also complicate the future reduction of the State’s backlog of bills and most likely delay reinstatement for the foreseeable future under the Governor’s terms.