On August 26, 2019, Illinois Governor J.B. Pritzker signed SB 1515 into law (Public Act 101-0585) (P.A. 101-0585), which establishes a 30-day threshold for nonresident taxability, changing the "base of operations" approach.

Nonresidents must pay tax on any compensation sourced to Illinois. If an employee performs his/her services wholly within Illinois, the employee's compensation is sourced to Illinois. If, however, an employee performed his/her services partly within Illinois and partly outside Illinois, prior law required the employee's compensation to be sourced to Illinois only if the employee's base of operations was in Illinois. In other words, Illinois employed an "all or nothing" test under prior law — either all an employee's compensation was sourced to Illinois, or none of the compensation was sourced to Illinois.

Under the new law, the employee's compensation earned while in Illinois is taxable in the state only after a nonresident employee has spent 31 work days in Illinois. Once that threshold has been met, the compensation associated with those days worked in Illinois is taxable by the state. In effect, Illinois is moving from an all-or-nothing to a pro-rata sourcing methodology. Please see Tax Alert 2019-1555 for a more thorough discussion of the impact on nonresidents.

P.A. 101-0585 becomes effective for tax years ending on or after December 31, 2020.

Impact on credits for taxes paid in other states

While not obvious on its face, the new law also affects Illinois residents and their ability to claim a credit for taxes paid in other states. Illinois provides such a credit to ensure multiple states don't subject a taxpayer to tax on the same income. Illinois' tax credit, however, does not provide a credit for actual taxes paid in other states. Instead, the credit is calculated based on the tax the resident would have paid in the other state if the other state had applied Illinois' laws.

Before enactment of P.A. 101-0585, when applying the Illinois tax credit standard, resident taxpayers were entitled to a credit for taxes they would have paid in another state if that other state used the "base of operations" approach to source nonresident compensation. Applying that standard, few nonresidents would find their income taxable in those other states, as an Illinois resident's base of operations is most often Illinois. Thus, before enactment of P.A. 101-0585, no credit was usually available to an Illinois resident with a base of operations in Illinois who paid tax in another state based on that state's law.

Example of calculating the credit under old and new law

For example, assume an Illinois resident employee whose base of operations is Illinois spends 16 days working in Connecticut, which uses a 15-day threshold for nonresident taxability, during the tax year. Those 16 days are sufficient to make the compensation earned in Connecticut taxable in Connecticut, and the employee files a tax return and pays tax to Connecticut on that income. As the employee is an Illinois resident, the employee's income is subject to tax in Illinois.

To compute the employee's credit for taxes paid to Connecticut under prior law, one would look to the amount of tax the employee would have paid in Connecticut if Connecticut employed the base of operations approach. Because Illinois is the employee's base of operations under these facts, the employee would have paid $0.00 in tax to Connecticut under the Illinois "base of operations" approach. As a result, the Illinois resident taxpayer would not be eligible to claim an Illinois credit for any of the taxes the employee paid to Connecticut, even though it resulted in the employee effectively paying state taxes twice on the same income.

The method for calculating the credit for taxes paid to another state has remained largely the same after P.A. 101-0585. The law continues to allow a credit based on the tax the resident individual would have paid in the other state if that other state applied Illinois law. When applying Illinois' new work days standard to taxes paid in other states, P.A. 101-0585 provides that the 30-day threshold does not apply. As a result, residents that pay tax in a jurisdiction employing a work days standard of less than 30 days (e.g., Connecticut as in the prior example), would be eligible for a full credit to offset Illinois tax on the same income.

Implications

The "base of operations" concept protected many nonresident individuals from Illinois personal income tax liability. The new 30-day threshold, however, brings Illinois in line with many other states that use a similar work days approach, although it is expected to result in more nonresidents being subject to Illinois personal income taxation.

For many Illinois residents, the change in compensation sourcing will bring welcome relief by finally allowing them to claim credit for taxes paid in other states. Employers in Illinois may see relief as well, as many Illinois employers aware of the inequity have effectively reimbursed their employees for their additional tax cost, on the basis that the tax cost was incurred at the employer's behest.

Because the new law doesn't become effective until tax years ending on or after December 31, 2020, Illinois employers and resident employees won't see this relief until next year at the earliest. At the same time, nonresident employees who worked in Illinois for more than 30 days in 2019 will generally not be obligated to pay Illinois personal income tax on that compensation.

Lastly, employers should keep in mind the potential compliance issues that will arise when any nonresident employee passes the 30-day threshold during 2020.

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