Recurrent Taxpayer Non-Compliance Issues

The following taxpayer recurrent non-compliance issues have been identified by IDOR for 2023.

Remote Retailer and Marketplace Facilitator Issues

The Audit Bureau continues to see issues with taxpayers complying with the rules associated with the Leveling the Playing Field for Illinois Retail Act. Examples of these issues include the following:

• Taxpayers meeting specific tax remittance thresholds are failing to register and subsequently failing to collect and remit retailers’ occupation taxes.
• Registered taxpayers are reporting use taxes instead of the correct retailers’ occupation taxes.  In some cases, they are reporting use taxes simply to make it easier to prepare tax returns. In other cases, they are making questionable nexus claims in an attempt to qualify as out-of-State sellers who are only required to collect use taxes.
• Many marketplace facilitators are not providing their marketplace sellers with a certification that notifies them that the marketplace facilitator is collecting and remitting the tax. This makes it challenging for the marketplace sellers to determine if they owe tax on their marketplace sales.
• Some remote retailers and marketplace facilitators are not retaining enough documentation to allow the Audit Bureau to verify the correct location of the sale. This makes it difficult to ensure the collected taxes are allocated to the proper local governments and the appropriate tax rate was applied.

Audits of cash businesses such as bars, restaurants, liquor stores, convenience stores, and gas stations continue to show compliance problems. Audited taxpayers are failing to keep or produce records, which results in significant tax underreporting. The records they are producing are often insufficient to verify their taxable sales. Failure to maintain proper records and production of insufficient records causes delays in the audit process which results in taxpayers postponing making payments for established liabilities. 

Retailers are failing to obtain or keep the documentation required to demonstrate that a sale qualifies for an exemption. Examples of frequently missing exemption documentation include resale certificates, farming machinery and equipment exemption certificates, building materials exemption certificates, and exemption documentation for sales to governmental, charitable, religious, or educational organizations. This failure to obtain or keep documentation leads to delays in completing audits as the taxpayers must then gather the documentation after the audit starts.

Taxpayers covered by the International Fuel Tax Agreement are failing to keep or produce the documentation required to verify the amounts claimed on their returns. These taxpayers are not properly maintaining logs or other support to document their miles driven, are not keeping purchase receipts, and are not adequately keeping track of the fuel withdrawn from bulk fuel storage tanks.

The Audit Bureau has identified a variety of compliance issues related to the purchases of aircraft, watercraft, and vehicles. Major issues include the following:

• Taxpayers continue to claim the rolling stock exemption on non-qualifying vehicles such as trucks that do not exceed the 16,000 pounds gross vehicle weight rating (GVWR) and vehicles improperly claimed to be used as limousines.
• Illinois residents are purchasing vehicles from Illinois dealers claiming the exemption available for out-of-State residents from reciprocal states.
• Taxpayers are claiming the farm machinery and equipment exemption on purchases of equipment such as ATVs, UTVs, and mowers which frequently do not qualify for the exemption. These taxpayers are failing to keep usage logs which makes verifying that the items are used in an exempt manner difficult during an audit.
• Purchasers of watercraft from private parties are listing a price below the actual purchase price in order to reduce the tax due on the purchase.
• Out-of-State residents who hangar or primarily use aircraft in Illinois are failing to file returns and pay the applicable use taxes due.

In general, apportionment calculations seem to give taxpayers difficulty. On a recurring basis, auditors have identified compliance problems with taxpayers failing to correctly report both the numerator and denominator of the apportionment factor. Improper calculations can result in a smaller apportionment of income to Illinois.

• Numerator / Reversionary Sales - Auditors often find instances where the numerator does not include items of income apportionable to Illinois. This includes sales of services received in Illinois and sales of tangible personal property shipped into Illinois. Auditors have also noted instances where taxpayers are not including receipts from the sale of tangible personal property shipped from Illinois to states where they are not taxable. Per 35 ILCS 5/304(a)(3)(B)(ii), such sales should be included in the sales factor numerator.
• Apportionment Denominator - Auditors have discovered instances where taxpayers have added items into the calculation of the apportionment denominator that should not be included, as well as excluded figures from the denominator when they should be included. For example, auditors have discovered instances where the apportionment denominator includes items of income such as foreign dividends, tax exempt interest, etc. that are being subtracted during the computation of base income. Per Continental Illinois Nat’l Bank & Trust Co. of Chicago v. Lenckos, 102 Ill. 2d 210 (1984), any gross receipt excluded from base income or subtracted in the computation of base income must be excluded from the apportionment numerator and denominator.

Partnerships are improperly reporting the subtraction modification allowed under the Illinois Income Tax Act Section 203(d)(2)(H) for personal service income (PSI) or reasonable allowance for compensation paid to their partners. Taxpayers are using this subtraction to zero out their taxable income and eliminate their replacement tax liability. In many cases, they have not maintained proper documentation to substantiate the subtraction amount as reported. When supporting documentation is requested, they either do not have the documentation, or they attempt to find a calculation that justifies their subtraction amount.

Taxpayers are not properly calculating their addition and subtraction modifications for bonus depreciation. While this is a timing issue, Illinois is not properly receiving tax revenues as would be expected under the law. Since Illinois is decoupled from federal bonus depreciation, many taxpayers simply calculate the modifications however they choose. In many cases, they are keeping separate calculations for state and federal depreciation. Illinois’ calculations are more complex than those of other states, so taxpayers simply plug their figures into the IL-4562.

Individual taxpayers are improperly reporting income and expenses on Schedule C or Schedule E. The following are common issues the Illinois Department of Revenue continues to find:

• Hobby losses - Taxpayers are using hobby losses to reduce their overall liability when they do not actually have a business that they intend to run for a profit.
• Under-reporting of income – Taxpayers may not be reporting all income related to their business activities.
• Over-reporting of expenses - Auditors have noticed that taxpayers may be claiming a small amount of income but disproportionately large amounts of expenses. Taxpayers are also claiming wage expenses even though they are not paying withholding.
• Claiming gambling losses in the improper place - There are instances where taxpayers are attempting to take gambling losses on the Schedule C, claiming they are professional gamblers, instead of properly claiming the losses on the Schedule A.

In each case, taxpayers are attempting to create a loss to offset other, unrelated income and reduce their tax liability. In some cases, the loss allows them to claim federal and state Earned Income Tax Credit (EITC).

Auditors have noted that some taxpayers are not primarily engaged in one of the qualifying activities required to claim the Replacement Tax Investment Credit. Auditors have also noted instances where the credit was claimed on non-qualified property, or the taxpayer has failed to report recapture credits from disqualified property. These errors all result in more credit being claimed than entitled. 

Per 20 ILCS 2520/4, the Illinois Department of Revenue (IDOR) is required to identify areas of recurrent taxpayer non-compliances with rules or guidelines and to report its findings and recommendations concerning such non-compliance annually. The information provided on this webpage will be included in the Illinois Department of Revenue’s Annual Report each year. Updates may be made prior to the annual reporting of this information if additional non-compliance issues arise that IDOR determines should be addressed.

(IDOR-RPT1-T - November 2023)