Tax experts say Illinois millionaires could try to flout progressive tax

Illinois budget (MGN)

(Illinois News Network) — J.B. Pritzker, Illinois’ next governor, promised higher taxes on the wealthy would provide for new state revenue to spend on everything from roads to schools, but some tax experts say other states have sometimes had trouble collecting from wealthier residents who own property and businesses elsewhere.

Pritzker, along with other Democratic lawmakers, have proposed changing Illinois’ Constitution to allow for graduated income tax rates that would require people who earn more to pay higher income tax rates.

If lawmakers succeed in taxing the state’s wealthy residents more, some could choose to move elsewhere. It’s relatively easy for well-to-do residents to declare a winter address in Florida as their main homestead, said Zach Gray with Wall Street Financial Group, a financial planning firm with locations in Bourbonnais, Bloomington, and other towns across Illinois. Such tax avoidance schemes have been problematic in other states, including New York.

“From what I have seen, it is a fairly simple thing to do,” Gray said. “I hate to say it, but I think it’s much more commonplace than we think.”

The Illinois Department of Revenue is responsible for making sure people pay their state taxes here. The department often audits residents who file taxes elsewhere. The most recent IRS data show more than 139,000 Illinoisans did just that in 2015 alone.

Illinois law defines a resident as someone living “in this State for other than a temporary or transitory purpose during the taxable year or who is domiciled in this State but is absent from the State for a temporary or transitory purpose during the taxable year.” The general rule is that people are taxed on the income they earn in a state. Intangible income, like investment earnings, is taxed in a person’s state of residence.

“Somebody running a hedge fund will get a modest salary of, say, $2 million, but the big thing is from their carried interest, which is intangible,” Forbes contributor Peter Reilly, a tax policy expert, said. “If the [Illinois] Department of Revenue gets aggressive, people who already have a place in Florida are going to say ‘screw this’ and they’ll register to vote in Florida and do a few other things, but they’re still doing business in Chicago.”

High tax states like New York and New Jersey aggressively pursue residents who try to dodge state taxes. Those states must prove the resident is in-state enough to qualify for taxation of income. Illinois, Reilly said, would likely have to do the same if the state started putting more of the income tax burden on the highest-earning residents.

Gray said he doesn’t know of anyone whose residency has been challenged, but knows of people who have switched their address or moved out of Illinois for tax savings.

“I literally had a conversation about this with one of my clients today,” he said. “They’re tired of a lot of the excessive taxation and they’re concerned about rising taxes and some of the things that have been proposed.”

One of the highest-profile residency revenue challenges in Illinois’ courts was over the Autonomous 3 Trust, an account owned by the Pritzker family founded in Illinois but moved to Texas, a state which has no income tax. The trust won the case in 2013 and didn’t have to pay Illinois taxes.

Reilly said the issue of domicile isn’t always clear. In court, it can come down to odd details like acquiring a resident hunting license in the state or if a former resident has their dog’s vaccination records licensed there. Statutory residence, however, is when revenue-seeking states like New York will seek to prove that an out-of-state resident had spent enough time in the Empire State to entitle themselves to part of their annual earnings.

“They’re going to tax you as a resident even though you’re domiciled someplace else,” he said. “The state where you’re domiciled is also going to tax you as a resident.”