taxable income Archives

Illinois Responds to Federal Tax Reform Bill by Proposing Legislation to Decouple from the FDII Deduction

The 2017 federal tax reform bill, known as the Tax Cuts and Jobs Act (Act), made a number of significant changes to the law, particularly to the international tax provisions of the Internal Revenue Code (IRC). Last month, Illinois joined the growing number of states responding to the Act by proposing legislation purporting to add-back the new federal deduction for foreign-derived intangible income (FDII). The FDII deduction, enacted in sub-part (a)(1)(A) of new IRC section 250, allows US corporate taxpayers a deduction in the amount of 37.5 percent of income earned from the sale of property to a person outside of the US for use outside of the US or the provision of services to a person outside of the US or with respect to property not located in the US. (For tax years beginning 2026, the deduction is reduced to 21.875 percent.)

Senate Bill (SB) 3152 (linked here) proposes an amendment to Section 203(b)(2) of the Illinois Income Tax Act (IITA) that would add back to taxable income the amount of a corporate taxpayer’s FDII deduction allowed under the IRC. Absent this amendment, the FDII deduction likely automatically would be included in Illinois’ corporate tax base: Illinois is a “rolling” conformity state (IITA section 1501(a)(11)), and the FDII deduction is a “special deduction” under the IRC which is incorporated in Illinois’ starting point for taxable income (IITA section 203(b)(1), (e) (For corporations IITA imposed on “taxable income” as defined under the IRC); IRC section 63 (“taxable income” includes “special deductions”)).

SB 3152 has been assigned to the Senate Revenue committee for review. It remains to be seen how, if at all, Illinois will respond to other changes enacted by the federal Act, particularly with respect to the other new international tax provisions, including those related to the deferred foreign earnings transition tax and global intangible low-taxed income, which include both additions and deductions at the federal level.

Implications of Federal Partnership Audit Rules for State and Local Taxation

The new federal partnership income tax audit rules, scheduled to take effect on January 1, 2018, will have significant implications for the state and local taxation of partnerships and their partners. Most, but not all, states that impose a net income-based tax adopt by reference the federal definition of taxable income, but those that do typically adjust that income to reflect differences between state and federal tax policies. Moreover, state revenue departments generally do not regard themselves as being bound by Internal Revenue Service interpretations of the Internal Revenue Code even when substantive Code provisions are incorporated into state law by reference. The federal statutory rules relating to partnership audits are procedural rules and not ones of substantive tax law, so they will not be automatically adopted by states that generally conform to Internal Revenue Code provisions relating to taxable income. State legislatures may decide to adopt some or all of the federal statutory rules, or they may decide to adopt none of them. Arizona has already adopted its own version of the federal rules, and other state revenue departments are considering recommending to their legislatures that the legislatures take similar action, but most states have not reacted to the federal rules at this time. (more…)