Common Errors Identified in Tax Audits
Compliance Alert
Sales Tax
Retailers - Exemption Documentation
Taxpayers claiming deductions either on the return or by elimination need to maintain the documentation to support the deductions and have available during the audit process. Examples of documentation for the deductions are the following:
- Sales for Resale – Completed CRT-61 (Certificate of Resale) with valid information
- Sales to Exempt Organizations – Copy of Tax Exempt Identification Letter issuedby the Illinois Department of Revenue
- Sales in Interstate Commerce – Bills of Lading, UPS or comparable business shipment log books, Delivery log books for own vehicles
Leasing Companies - True v Conditional
If the lease is a true lease (no nominal dollar purchase option available at end of lease), the lessor is responsible for Use Tax at the time that the tangible personal property is placed into service. The leasing company can bill the lessee for ‘reimbursement of use tax paid’; however the leasing company cannot collect tax from the lessee on the rental receipts received monthly. If the lease is a conditional sales contract (nominal dollar purchase option available at end of lease) the leasing company should treat the lease in the same manner as a retail sale.
Manufacturer's Purchase Credit
If a retailer is accepting Manufacturer’s Purchase Credits on sales qualifying for the credit the retailers needs to report the sales on Line 1 of the ST-1 and report the amount of MPC credit on Line 16a of the ST-1. Failing to report the sales on Line 1 could result in local governments not receiving their non-state taxes because MPC is only the state portion of the taxes collected. An earner and user of MPC must file the appropriate forms (ST-16’s and ST-17’s) by June 30th of the following year.
Use Tax
All taxpayers need to voluntarily comply with the Illinois Use Tax laws and remit use tax to the Illinois Department of Revenue when the purchaser of tangible personal property for use or consumption fails to remit Illinois Use Tax to the supplier or vendor.
Income Tax
Income Exempt from Tax
Certain interest and other income is exempt from Illinois Income Tax by virtue of Illinois or US law, Illinois or US Constitution, or US treaties. In order to take the exemption, taxpayers must claim it as a subtraction modification on their Illinois return. The amount subtracted is net of any bond premium amortization that’s deducted Federally. The subtraction is allowed only to the extent that it’s included in Federal income. For a quick guide of the type of interest and other income that is exempt from Illinois taxation, please review Publication 101, which is available on our website. Regulation 100.2470 is the Department’s formal authority on the subject. If the item is not identified in Publication 101, it does not qualify for the exemption cited by Regulation 100.2470.
80/20 Related Party Expenses
Illinois filers cannot deduct some interest, “intangible expenses” (such as royalties, and losses on sales of intangible assets), or insurance premium expenses from transactions with a taxpayer who would be a member of your unitary business group except that 80 percent or more of its business is conducted outside the United States, or conducted with an affiliated company that would have been a member of the unitary group except that they use a different apportionment method (noncombination rule company). Interest, intangible expenses, and insurance premium expenses deducted Federally in excess of taxable dividends received from 80/20 company or noncombination rule companies must be added back, unless an exception applies. Please see the instructions to Schedule 80/20 (Related Party Transactions) and Regulation 100.2430 for further guidance. Taxpayers must have clear & complete documentation on file to support any exception claimed.
80/20 Determinations
We have noted that some companies are not using the proper criteria in making 80/20 determinations. Illinois law requires companies to be excluded from a unitary group only if 80% or more of it’s activities are conducted outside of the US. The US is defined as the 50 states & the District of Columbia. It does not include US territories, possessions, etc. Also, the 80/20 test must be developed based on the industry that the taxpayer is involved in. The property and payroll factors are only used for companies that apportion income via the single sales factor. Special apportioning companies must include in their 80/20 test numbers that pertain to their industry (insurance companies use premiums, transportation companies use mileage, etc.) For further guidance, please review Section 1501(a)(27) of the Illinois Income Tax Act.
Business Income
For transactions occurring on or after July 30, 2004, "business income” is defined as all income that may be treated as apportionable business income under the Constitution of the United States. The Department has found that many taxpayers are still applying the former definition of business income which was based on the functional test and transactional test. Please see Regulation 100.3010 for further guidance.
Recapture of Business Expenses
If in prior years income from an asset or business was classed as business income, and in a later year is shown to be non-business, taxpayers must add back and recapture all expenses from that asset or business that was deducted in the later year and 2 immediately preceding taxable years. This recapture should be added back as business income in the year that the asset or business was disposed of. For further guidance, please see Regulation 100.2405(d).
