• In 2017, the State of Illinois passed a new budget, which included an income tax rate increase from 3.75% to 4.95%.
• Because the rate increase became effective on July 1, 2017, Illinois is allowing taxpayers to choose between two methods to calculate their state tax liability for 2017.
• Depending on when a taxpayer earned income throughout 2017, they may be able to reduce their tax bill for the year by using the appropriate method.
On July 6, 2017, a new budget was passed by the State of Illinois, which included an income tax rate increase from 3.75% to 4.95% for individuals. The increase was effective July 1st, 2017, which created some question as to how this mid-year tax rate change would ultimately affect an individual’s 2017 Illinois income tax return.
The State of Illinois has provided further guidance on this issue, and it is something that Illinois taxpayers should consider closely when filing their taxes for 2017. According to an informational bulletin issued by Illinois¹, a taxpayer may compute their tax using either the “blended” rate of 4.3549% to all net income received in 2017, or elect to use the “Specific Accounting” method, which applies the old 3.75% rate to net income received prior to July 1, 2017, and the new 4.95% rate to net income received on or after July 1, 2017. The blended rate is a weighted-average rate based on the number of days under the old rate of 3.75% (181 days) and the new rate of 4.95% (184 days).
According to the bulletin and the Form IL-1040, the blended tax rate will be the default calculation for 2017. If a taxpayer wishes to use the Specific Accounting method, this will require the completion of a Schedule SA attached to the Illinois return, which calculates taxable income both before and after the tax rate increase, as though it was received in two different years. If a taxpayer elects to use this Specific Accounting method, it is an irrevocable election.
For many taxpayers, the use of the blended rate will make sense to calculate their tax liability. This would be the case if most of their income was earned equally over the course of the year, or if they had larger amounts of income earned in the second half of 2017 when the higher rate would have applied. The blended rate may also make sense for those taxpayers that report taxable income from flow-through entities, such as partnerships and trusts. Under the Specific Accounting method, items of income, deduction or loss from these flow-through entities must be treated as received on the last day of the pass-through entity’s taxable year, or in most cases, December 31st.
However, for some taxpayers that had more income attributable to the first half of 2017, using the default blended rate method may not be the best answer. For example, if rather than income, a taxpayer’s flow-through entity generated taxable losses for the year, all the losses treated as being received at the end of 2017 would be beneficial under Specific Accounting. Another example is if a taxpayer recognized a significant capital gain early in 2017 when the rates were lower, a blended rate will calculate a larger tax liability than under the Specific Accounting method. This could also be the case if a taxpayer received a significant bonus in the first half of the year, before the application of the higher tax rate. In situations like this, the Specific Accounting method should be used.
Consider an Example of How Much Can Be Saved
Assume Sarah, a full year Illinois resident, had total taxable income of $440,000 in 2017. Assume further that included in this taxable income is a $175,000 bonus that she received on March 1, 2017, the remaining income being wages of $165,000 earned evenly during the year. If Sarah were to follow the default method of using the blended rate for 2017, her total tax would be $19,161 ($440,000 x 4.3549%). If she were to elect the Specific Accounting method, she would instead apply the old rate to $307,500 ($175,000 + $132,500), and the new rate of 4.95% to $132,500, resulting in a total tax of $18,090, a savings of $1,071.
In the end, the change in the Illinois tax rate will result in higher state income taxes for taxpayers. However, with the guidance on how this rate increase may be calculated in 2017, there may be a way to reduce the larger tax bill, at least for 2017. Including the Schedule SA on your 2017 Illinois return will result in extra work, as it will require you to specifically allocate your income for the year. But in some cases, this extra analysis will result in a more favorable bottom line. At Capstone, we will be analyzing our clients’ tax situations to recommend the more favorable outcome. If you have questions regarding the Illinois tax update, please contact your Capstone service team.
¹Illinois Department of Revenue, Tax Rates Bulletin (PDF)