Illinois State Taxation & Reporting of Foreign Income

Do I Have to Pay Illinois State Taxes on Foreign Income?  

Illinois Department of Revenue Can be a Nightmare when proving domicile

If you have a federal return with an IL address and did not file an IL tax return, expect an audit letter from the State.

Thankfully they allow the foreign earned income exclusion however, if you take the foreign tax credit in lieu of the FEIE, you will be subject to state taxation if you are considered domiciled in Illinois, as the Federal AGI is calculated before the application of the tax credit. The Federal AGI is the State of Illinois's starting point for calculating the state return.

I have had several cases where ex-pats did not file an Illinois return but later found out due to the State and the IRS sharing data with each other through a “variety of ongoing initiatives.” Even non-expats who change their residency to another state and filed a previous year’s IRS return that did not file but used their old IL address on the return should be expected to be audited by the State.

Residency in the Illinois Income Tax Act

Residency Defined

Illinois imposes income tax on every individual who is a resident of this State. An individual is an Illinois resident if (1) they are in Illinois for other than a temporary or transitory purpose during the taxable year or (2) they are domiciled in Illinois but are absent for a temporary or transitory purpose during the taxable year.

First, an Illinois resident is someone in this state for other than a temporary or transitory purpose. Obviously, a vacationer or businessperson staying in Illinois for a week is not a resident – they are only here temporarily. For a stay NOT to be temporary or transitory, a longer, indefinite period is required, likely coupled with no definite intention to leave Illinois. Those persons will be considered residents of Illinois.

Second, an Illinois resident is ‘domiciled’ in this State, and only absent for a temporary or transitory purpose. The Illinois Administrative Code defines domicile as, "the place where an individual has his or her true, fixed, permanent home … the place to which he or she intends to return wherever absent." It should be noted you can only have one domicile at a time. Of course, in our transient society, domicile is not as clear as it used to be. There are a number of ‘snowbirds’ from Illinois that spend a good deal of the winter in another state – which they may even call ‘home.’ For these snowbirds to claim they are domiciled in another state will require looking at the facts and circumstances of each case.

Once the State of Illinois issues a determination letter you can challenge it—even if the Examination Response itself does not mention any protest rights—but you must do so in a timely and properly formatted manner according to Illinois tax dispute procedures.

Below is an outline of the steps she should take and the associated procedural requirements:

1. File a Formal, Written Protest:
   Illinois law provides that if you disagree with a tax determination or adjustment (including one affecting your domicile), you must submit a written protest*. In many cases—such as those involving deficiency or domicile–determinations—the protest must be filed within the period prescribed by Illinois statutes (commonly within 60 days from the mailing date of the notice, or 150 days if you are outside the United States).

2. Explain Your Grounds Clearly:
   You should explain the situation in detail in your written protest, using all relevant facts and supporting evidence. For example, if the Department relied on your renewal of an Illinois driver’s license, you need to show that this renewal does not reflect a change in domicile. For example, you may include evidence such as:

   • Documents proving your long‐term residence in the a foreign country (e.g., lease or property records, utility bills, voter registration, or residency certificates).

   • A statement that your renewal of an Illinois driver’s license was for convenience or due to other practical reasons and does not necessarily indicate that your domicile has changed.

3. Include All Supporting Documentation:
   Make sure to attach copies of any documentary evidence supporting your claim to foreign residency. This helps the Department understand that, despite the renewed driver's license, you maintain your true, fixed and permanent home abroad.

4. Meet the Statutory Deadline and Format Requirements:
   Even if the Examination Response letter is not phrased as a “notice” setting out protest rights, you are still subject to the standard deadlines and requirements under Illinois law. For instance, the procedures governing disputes such as those found under provisions similar to Section 908 of the Illinois Income Tax Act require that the protest be submitted in writing and within the statutory time limit. (See, e.g., general principles cited in cases regarding administrative challenges and the exhaustion of remedies in Illinois tax disputes.)

5. Request an Informal or Formal Hearing (if available):
   If the protest is not resolved to your satisfaction, many Illinois disputes allow you to request a hearing before the Illinois Independent Tax Tribunal or another appropriate administrative forum*. The protest should state that you are requesting such a hearing if you wish to have your case reviewed further.

6. Consult the Applicable Rules and Statutes:
   Even though the letter itself omitted protest rights, you should review Illinois Department of Revenue publications or consult a tax professional to ensure you comply with all relevant procedures. In Illinois, the protest process generally requires that all arguments and supporting evidence be filed with the Department within the statutory period. Failure to follow these rules may result in the loss of your right to challenge the determination.

7. Consider Professional Assistance:
   Given that questions of domicile and associated administrative procedure can be fact‐intensive—and the Department’s findings may rely on factors (such as a driver’s license renewal) that can be weighed differently in the administrative record—it is advisable to work with a tax attorney or specialist familiar with Illinois tax dispute procedures.

In summary, promptly file a detailed written protest (including all supportive evidence demonstrating her residency in the foreign country) within the applicable statutory period. This written protest should clearly explain why the reliance on the driver’s license renewal (as an example) is misplaced and request review (and, if necessary, a formal hearing) of the domicile determination. By following the prescribed Illinois procedures—such as timely filing in writing and providing detailed supporting documentation—she will preserve your right to dispute the determination.

It is important to note that the underlying principles governing the exhaustion of administrative remedies and the necessity of a timely, well-supported protest have been emphasized in Illinois cases addressing tax disputes.

*Which would be better, the Illinois Tax Tribunal or a Discretionary Hearing, when disputing IL domicile disputes?

When disputing Illinois domicile disputes, taxpayers have two primary routes: the Illinois Tax Tribunal and a Discretionary Hearing before the Illinois Department of Revenue. Below is a detailed comparison of the advantages and disadvantages of each route, including jurisdiction, process, presiding officials, and the types of issues they handle.

Illinois Tax Tribunal

Jurisdiction

Scope: The Illinois Tax Tribunal has jurisdiction over disputes involving Illinois income tax, sales tax, and other state taxes where the amount in controversy exceeds $15,000.

Authority: It is an independent administrative body with tax expertise, designed to resolve tax disputes between the Illinois Department of Revenue and taxpayers.

Process

Initiation: Taxpayers must file a petition with the Tax Tribunal within 60 days of receiving a notice of deficiency or other adverse determination from the Department of Revenue.

Procedure: The process is formal and includes the filing of pleadings, discovery, and a hearing. The Tribunal follows the Illinois Administrative Procedure Act.

Hearing: Hearings are conducted similarly to court trials, with the presentation of evidence, witness testimony, and cross-examination.

Presiding Officials

Administrative Law Judges (ALJs): The Tribunal's hearings are presided over by ALJs who have substantial knowledge of state tax laws and the making of a record in a tax case.

Types of Issues Handled

Complex Tax Disputes: The Tribunal handles complex tax disputes, including those involving domicile, residency, and other substantive tax issues.

Advantages

Expertise: The Tribunal's ALJs have specialized knowledge in tax law, which can be beneficial for complex domicile disputes.

Formal Process: The formal process allows for comprehensive discovery and the presentation of detailed evidence, which can be advantageous in proving domicile.

Binding Decisions: Decisions by the Tribunal are binding and can be appealed to the Illinois Appellate Court, providing a clear path for further review if necessary.

Disadvantages

Formality: The formal process can be time-consuming and may require legal representation, which can be costly.

Strict Deadlines: The requirement to file a petition within 60 days can be challenging for taxpayers who need more time to prepare their case.

Discretionary Hearing Before the Illinois Department of Revenue

Jurisdiction

Scope: The Department of Revenue handles a wide range of tax issues, including domicile disputes, through its administrative processes.

Authority: The Department has the authority to review and adjust tax assessments and determinations.

Process

Initiation: Taxpayers can request a discretionary hearing by filing a protest with the Department within 60 days of receiving a notice of deficiency or other adverse determination.

Procedure: The process is less formal than the Tribunal. It involves submitting written arguments and evidence, and may include an informal conference or hearing.

Hearing: Hearings are less formal and may not involve the same level of procedural rigor as those before the Tribunal.

Presiding Officials

Hearing Officers: Hearings are conducted by hearing officers who are employees of the Department of Revenue. These officials may not have the same level of independence or specialized tax expertise as the Tribunal's ALJs.

Types of Issues Handled

Varied Tax Disputes: The Department handles a broad range of tax issues, including domicile and residency disputes, but the process may be more suited to less complex cases.

Advantages

Informality: The less formal process can be quicker and less costly, making it accessible for taxpayers without legal representation.

Flexibility: The Department may offer more flexibility in scheduling and procedural requirements, which can be beneficial for taxpayers.

Disadvantages

Lack of Independence: Hearing officers are employees of the Department, which may raise concerns about impartiality.

Limited Expertise: Hearing officers may not have the same level of specialized tax knowledge as the Tribunal's ALJs, which can be a disadvantage in complex domicile disputes.

Non-Binding Decisions: Decisions by the Department can be appealed to the Tribunal, but this adds an additional layer of process and potential delay.

Conclusion

Illinois Tax Tribunal:

Best for: Complex domicile disputes requiring detailed evidence and expert adjudication.

Pros: Specialized tax expertise, formal process, binding decisions.

Cons: Time-consuming, potentially costly, strict deadlines.

Discretionary Hearing Before the Illinois Department of Revenue

Best for: Less complex disputes or when a quicker, less formal resolution is desired.

Pros: Quicker, less costly, more flexible.

Cons: Potential lack of impartiality, limited expertise, non-binding decisions.

Taxpayers should consider the complexity of their domicile dispute, their need for specialized tax expertise, and their preference for formality versus informality when choosing between these two routes.

To have your return prepared, please send me an email to get the process started.  My consulting is fee $200 per hour if you wish me to review your case.

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