Recurrent Taxpayer Non-Compliance Issues

The following taxpayer recurrent non-compliance issues have been identified by the Illinois Department of Revenue (IDOR) for 2024.

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 remit retailers’ occupation taxes. (See 86 Ill. Adm. Code 131.125, 86 Ill. Adm. Code 131.145, and PIO-113, Out-of-State Seller and Remote Retailer Registration Flowchart.)
• 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 having a physical presence in order to avoid a retailers’ occupation tax liability in many different taxing jurisdictions. (See 86 Ill. Adm. Code 131.110, 86 Ill. Adm. Code 131.130, and PIO-104, Leveling the Playing Field for Illinois Retail Act Flowchart.)
• 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 sellers to determine if they owe tax on their marketplace sales. (See 86 Ill. Adm. Code 131.145 and CRT-63, Sales Through Marketplace Facilitator Certificate.)
• 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. (See 86 Ill. Adm. Code 131.125 and 86 Ill. Adm. Code 131.145.)
• Some remote retailers and marketplace facilitator filers are not properly determining whether their shipping charges are taxable. (See 86 Ill. Adm. Code 130.415.)

Audits of cash businesses such as bars, restaurants, liquor stores, tobacco stores, grocery stores, convenience stores, and fuel stations continue to show compliance problems.

• Audited taxpayers are failing to keep or produce records. The records produced are often insufficient to verify 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. (See 86 Ill. Adm. Code 130.801.)
• Some cash businesses are overreporting their sales subject to the low rate of tax in an effort to reduce their tax liability while still reporting the correct amount of total sales. (See 86 Ill. Adm. Code 130.310 and 86 Ill. Adm. Code 130.311.)
• Some fuel stations are incorrectly reporting taxable fuel as exempt fuel. (See 86 Ill. Adm. Code 130.320.)

Retailers are increasingly adding additional charges to their sales invoices such as credit card transaction fees and banquet room fees. They often fail to collect taxes on these fees even though these fees are costs of doing business that are subject to tax. (See 86 Ill. Adm. Code 130.410, 86 Ill. Adm. Code 130.2145, and CA-2012-11.)  

Retailers are also having trouble determining the tax impact of locally imposed liquor and food and beverage taxes. Depending on the legal incidence of the local tax, it should either be includable in gross receipts and subject to ROT or deductible and not subject to ROT. For example, the Chicago Restaurant Tax should be included in gross receipts and is subject to ROT, but some Chicago restaurants are failing to include the Chicago Restaurant Tax in gross receipts. For the taxes that are deductible, some retailers fail to keep records showing they remitted the taxes to the local government. (See 86 Ill. Adm. Code 130.435.)

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, farm machinery and equipment exemption certificates, building materials exemption certificates, marketplace facilitator 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. (See PIO-101, Illinois Sales & Use Tax Matrix, for guidance on different types of exemption documentation required to be obtained by retailers.)

Some retailers obtain exemption certificates but do not retain the documentation required to tie those certificates to specific sales nor do they maintain proof that payment was made by the exempt organization. A retailer must identify the sales made to the specific exempt organization in their books and records and provide proof payment was made by the exempt organization. If they fail to do so, IDOR must disallow the exemptions. (See 86 Ill. Adm. Code 130.2081.)

Retailers and servicepeople are not remitting Retailers’ Occupation Tax or Service Occupation Tax for durable medical equipment and other tangible personal property transferred to Medicare beneficiaries under Medicare Parts A and B and paid for by Medicare Administrative Contractors. (See CA-2024-01, Sales Made to Medicare Administrative Contactors.)

The Audit Bureau has identified a variety of compliance issues related to the International Fuel Tax Agreement:

• 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 fuel purchase receipts, and are not adequately keeping track of the fuel withdrawn from bulk fuel storage tanks.
• IFTA taxpayers are not keeping copies of their system generated Electronic Logging Device (ELD) daily log details which are needed for verification on completeness of the trips taken. These taxpayers are only keeping copies of the mileage state summaries. ELD systems’ reports are normally only accessible for the previous six months, which is problematic when auditing periods prior to that timeframe. (See the MFUT-53, Illinois IFTA Carrier Compliance Manual and 86 Ill. Adm. Code 500.345.)
• IFTA taxpayers are purchasing more decals than their reported active trucks and are unable to show the copies of any unused decals after the year ends. This makes it difficult to determine whether the taxpayer is using those decals with vehicles not reported in their records.

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. (See 86 Ill. Adm. Code 130.340.)
• Illinois residents are purchasing vehicles from Illinois dealers claiming the exemption available for out-of-State^* residents from reciprocal states. There is a similar issue with Illinois residents establishing out-of-State LLCs in order to improperly claim a nonresident exemption on vehicles intended to be used in Illinois. (See 86 Ill. Adm. Code 130.605.)
• 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. (See 86 Ill. Adm. Code 130.305.)
• 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. (See 86 Ill. Adm Code 153.110.)
• Out-of-State residents who hangar or primarily use aircraft in Illinois are failing to file returns and pay the applicable use taxes due. (See 86 Ill. Adm. Code 150.310.)
• Leasing companies – either Illinois leasing companies or leasing companies outside of Illinois – selling items coming off a lease in Illinois where the item must be titled or registered by an agency of Illinois state government (e.g., motor vehicles, watercraft, aircraft, and trailers), are not properly determining whether they are considered to be selling such items at retail in Illinois. Leasing companies engaged in the business of leasing or renting first division motor vehicles, aircraft, or watercraft to others and who, in connection with such business, sell any used first division motor vehicle, aircraft, or watercraft to a purchaser for use and not for the purpose of resale, is a retailer engaged in the business of selling that item at retail. Leasing companies selling second division motor vehicles or trailers off-lease are also considered to be selling such items at retail if they are otherwise engaged in selling that type of property at retail. These leasing companies must register with IDOR and are obligated to collect Illinois Sales Tax and report these sales on Form ST-556, Sales Tax Transaction Return. (See 86 Ill. Adm. Code 130.2013(e).)

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 IDOR 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 several recurring issues with Replacement Tax Investment Credits that result in taxpayers claiming more credit than they are entitled to receive:

• Some taxpayers are not meeting the conditions required to claim the Replacement Tax Investment Credit. 
• Taxpayers are claiming credit on non-qualified property.
• Taxpayers are failing to report recapture credits from disqualified property.
• Taxpayers are claiming the credits on property put into service after 2018, which is not permissible according to IITA §201(e)(8).

One of the most prevalent compliance issues faced by IDOR is non-filed returns. This is a major issue, especially with individual income taxpayers. In accordance with information exchange agreements, IDOR receives information from the Illinois Comptroller’s Office and the IRS regarding taxpayers that have Illinois sourced income but are found to have not filed the required Illinois returns. The Audit Bureau contacts these taxpayers and encourages them to file their state return or to provide supporting information that confirms they are not required to file with the State of Illinois. There have been over 102,000 non-filer taxpayers for individual income tax with more than $244 million in liability established in the past fiscal year alone.

Non-filed business income tax returns are also problematic. In a recent non-filer project, the Audit Bureau has been encountering transportation companies that have revenue miles within Illinois, but they have not filed Illinois business income tax returns to apportion their income based upon Illinois revenue miles.

When taxpayers are audited by the IRS, the federal audit results often include changes that would result in increased Illinois tax liability. Taxpayers are required to report these changes from the federal Revenue Auditor’s Report (RAR) to Illinois within 120 days of the federal finalization date. Taxpayers often fail to report federal changes that affect their Illinois returns, so the Audit Bureau must contact them to make the required changes. This applies to several taxes including individual income tax, business income tax, and withholding tax. (See 35 ILCS 5/506(b).)

Some taxpayers are trying to avoid Illinois taxation by filing as residents of states with no income tax, such as Florida, while still maintaining residences in Illinois. The Audit Bureau is receiving referrals from the Individual Processing Division, the Federal State Exchange Unit, and the Bureau of Criminal Investigations for situations that appear questionable. Rules for residency can be found in (See 86 Ill. Adm. Code 100.3020.)

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.

Recurrent Taxpayer Non-Compliance Issues (November 2023)

* As used in this document, “out-of-State” refers to outside of the State of Illinois.

(IDOR-RPT1-T - October 2024)