Could Illinois residents claim a Schedule CR credit when a reciprocal state withheld tax from deferred compensation that state was not entitled to tax?

Plain-English summary

The residents could not convert tax mistakenly paid to a reciprocal state into an Illinois Schedule CR credit. Their former out-of-state employer paid nonqualified deferred compensation after they had moved to Illinois. The reciprocal agreement provided that the other state did not tax wages or other employee compensation of Illinois residents.

The other state's revenue department confirmed that tax withheld or paid on the deferred compensation could be refunded. Because no tax was legally due there, Illinois denied the credit and directed the residents to file the appropriate refund claim in that state.

The GIL did not make the result unconditional. If the other state determined that the income was properly taxed there, Illinois would allow a credit. It also noted that the reciprocal agreement did not necessarily protect non-wage income.

What this means for you

An Illinois resident credit generally relieves valid double taxation; it does not replace a refund claim for tax another state collected contrary to reciprocity. Confirm whether the payment is employee compensation and obtain the other state's final position.

Common questions

Q: Could the residents keep the other-state payment and claim an Illinois credit?
A: No, when that tax was not legally due.

Q: What remedy did the GIL identify?
A: A refund claim with the reciprocal state.

Q: Could an Illinois credit ever be available?
A: Yes, if the other state determined that its tax was properly imposed.

Citations and references

• 35 ILCS 5/601(b)(3) — resident credit and limitation
• 35 ILCS 5/302(a), (b) — compensation allocation and reciprocal agreements
• 35 ILCS 5/304(a)(2)(B) — compensation paid in a state

Subject

Credits – Foreign Tax

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2013.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2013/it-13-0015.pdf

Original ruling text

IT 13-0015 GIL 12/31/13 Credits – Foreign Tax
Illinois resident who had income tax of a reciprocal state withheld from wages in error must file a
claim for refund with that state, and cannot claim a foreign tax credit for the taxes.

December 31, 2013

Re:

Request for General Information Letter; TAXPAYER

Dear Xxxx:
This is in response to your letter dated November 1, 2013 in which you request a legal tax ruling
whether certain correction notices issued by the Department of Revenue (“Department”) were correct.
The Department’s regulations require that the Department issue only two types of letter rulings,
Private Letter Rulings (“PLRs”) and General Information Letters (“GILs”). PLRs are issued by the
Department in response to specific taxpayer inquiries concerning the application of a tax statute or
rule to a particular fact situation. A PLR is binding against the Department, but only as to the taxpayer
issued the ruling and only to the extent the facts recited in the PLR are correct and complete. GILs do
not constitute statements of Department policy that apply, interpret or prescribe the tax laws and are
not binding against the Department. See 2 Ill. Adm. Code 100.1200(b) and (c). The nature of your
letter and the information provided require that we respond with a General Information Letter.
Your letter states as follows:
We are writing this letter for a legal tax ruling concerning the return correction notice issued by
the Illinois Department of Revenue concerning the individual income tax account of
TAXPAYER. A copy of this notice is enclosed for your reference.
The income tax issue involves TAXPAYER’s receipt of non-qualified deferred compensation
paid by his prior employer, COMPANY A, a STATE company from CITY, STATE.
Furthermore, this deferred compensation stems from his employment while the taxpayers were
residents of the State of STATE. They moved to Illinois in 20XX.
In 20XX, TAXPAYER has two W-2 tax forms from COMPANY A and the COMPANY B, which
total $XXX,XXX of wages. While there is a reciprocity agreement between Illinois and STATE
concerning wages earned by residents of these states, TAXPAYER as a non-resident of
STATE was required to declare this non-qualified deferred compensation as STATE source
income in 20XX. As evidence, we are enclosing the nonresident STATE tax rules pertaining to
this highlighted for your reference. In connection with the out-of-state taxation of wages
received by TAXPAYER, we computed a tax credit for tax paid to Other States via Schedule
CR on their 20XX Illinois tax return.
Illinois tax regulations also tax their non-residents for deferred compensation that was earned
while a taxpayer was a resident of the State of Illinois. This tax regulation was upheld by an
Illinois court case, IT 10-04, a copy which is enclosed. The point that we’re making is the
opposite of the IT 10-04 case, inasmuch that an Illinois resident should be allowed to declare a
tax credit for tax paid to Other States as an exception to the otherwise general tax principles
involving reciprocity.
RESPONSE

Section 302(a) of the Illinois Income Tax Act (35 ILCS 5/302) provides that, with respect to
nonresidents:
All items of compensation paid in this State (as determined under Section 304(a)(2)(B)) to an
individual who is a nonresident at the time of such payment and all items of deduction directly
allocable thereto, shall be allocated to this State.
This provision is also relevant to residents who pay income tax to other states and are allowed a
credit for such taxes under Section 601(b)(3) of the Illinois Income Tax Act (35 ILCS 5/601), because
that paragraph provides, in part:
(t)he credit provided under this paragraph for tax paid to other states shall not exceed that
amount which bears the same ratio to the tax imposed by subsections 201(a) and (b)
otherwise due under this Act as the amount of the taxpayer's base income that would be
allocated or apportioned to other states if all other states had adopted the provisions in Article
3 of this Act bears to the taxpayer's total base income subject to tax by this State for the
taxable year.
Under this provision, employee compensation that is “paid in this State” under Section 304(a)(2)(B) of
the Illinois Income Tax Act (35 ILCS 5/304) cannot be included in the numerator of the fraction used
to compute the limitation on a resident’s credit for taxes paid to another states. In the simplest case, a
resident whose only income is employee compensation “paid in this State” would not be entitled to a
credit for taxes paid to any other state on that compensation.
Section 302(b) of the Illinois Income Tax Act (35 ILCS 5/302) provides:
The Director may enter into an agreement with the taxing authorities of any state which
imposes a tax on or measured by income to provide that compensation paid in such state to
residents of this State shall be exempt from such tax; in such case, any compensation paid in
this State to residents of such state shall not be allocated to this State.
Under that authority, the States of Illinois and STATE entered a “reciprocal agreement” effective
January 1, 1974, pursuant to which neither state taxes, or requires withholding from, wages earned in
the state by a resident of the other state.
The instructions to the Schedule CR expressly provide:
If you earned wages, salaries, tips, or other employee compensation from an employer in
Iowa, Kentucky, Michigan, or Wisconsin while you were a resident of Illinois, you are covered
by a reciprocal agreement between that state and Illinois and are not taxed by that state on
your compensation. However, you may be taxed on other income.
The undersigned spoke with a representative of the STATE Department of Revenue, and they
confirmed that if COMPANY A or the COMPANY B withheld taxes or the taxpayers paid tax to STATE
based on the deferred compensation, the taxpayers may claim a refund from STATE. Because no
STATE tax was due from the taxpayers, they may not claim a credit on Schedule CR for that tax.
They must file the appropriate forms with STATE to receive a refund of taxes withheld or paid in error.
See also the enclosed copy of the STATE Publication XXX and XXX, Tax Information for Part-Year
Residents and Nonresidents of STATE.
Accordingly, the taxpayers are not allowed a credit against their Illinois income tax liability for taxes
paid to STATE on deferred compensation earned during 2012 because they were Illinois residents for

the entire year. If STATE taxes were withheld from those wages, or they mistakenly filed and paid
taxes to STATE, they must file a refund claim with STATE. A credit on Schedule CR is only available
for taxes paid to STATE on non-wage income taxable by that State.
However, should STATE make a determination that this income was properly taxed in STATE, then
the taxpayers would be allowed a credit in Illinois.
As stated above, this is a general information letter which does not constitute a statement of policy
that applies, interprets or prescribes the tax laws, and it is not binding on the Department. If the
taxpayers are not under audit and they wish to obtain a binding Private Letter Ruling regarding their
factual situation, please submit all of the information set out in items 1 through 8 of Section
1200.110(b). If you have any further questions, you may contact me at (217) 524-7580.
Sincerely,

Matthew Crain
Associate Counsel (Income Tax)