Understanding Illinois Income Tax
For those living in Illinois, income taxes are a hard fact of life. And while we all have to pay them, few people actually understand the nuances of how income tax is structured and calculated. With rumors about Governor Pritzker’s proposed progressive income tax plan floating around, now is the perfect time to answer your tax questions, settle some debates and debunk the myths.
In this blog, we will take a deep dive into Illinois’ personal income taxes and explain:
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Current income tax rates
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Who pays income tax
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How to calculate your individual income tax
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Current tax exemptions and credits
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Proposed income tax changes
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What these changes mean for you
Current Tax Rates (August 9, 2019)
In addition to federal income taxes, Illinois imposes its own state income taxes on individuals, trusts, estates and corporations. There are four different tax types under the Illinois income tax umbrella. These are:
- Business Income Tax – 7% of net income for corporations and 4.95% of net income for trusts and estates
- Individual Income Tax – 4.95% of net income
- Personal Property Replacement Tax – 2.5% of net income for corporations (S corporations excluded) and 1.5% of net income for partnerships, trusts and S corporations
- Withholdings (payroll) – 4.5% of net income withheld from
- employee compensation based on the number of allowances claimed by the employee,
- Illinois lottery winnings each time a single payment is over $1,000 for both Illinois residents and non-residents, and
- other gambling winnings paid to an Illinois resident
if the winnings are subject to federal income tax withholding requirements.
All Illinois income taxes operate under a flat tax rate, meaning that everyone pays the same percentage of their net income regardless of how much money they make.
Who Pays Individual Income Tax?
Anyone who brings in income within the state of Illinois is required to pay state income tax. This, of course, includes Illinois residents as well as non-residents who live outside of the state but work in Illinois. That being said, there is an exception to this rule for residents of Michigan, Iowa, Kentucky and Wisconsin. Illinois has reciprocity with these states, meaning residents can work across state lines without paying Illinois income tax.
Calculating Your Individual Income Tax
Because everyone pays the same individual income tax rate, calculating your tax amount is relatively simple. To begin your calculation, you will need to know your adjusted gross income (AGI), which you can find on your tax form.
Your AGI is a representation of your income after any adjustments have been made. Adjustments are automatic deductions from your gross income for things like student loan interest you paid throughout the year or contributions you made to an IRA.
Once you have determined your AGI, it is time to calculate what Illinois terms your “base income.” This is the number the state will use to determine what taxes you owe. Your base income is your AGI adjusted to include/exclude certain types of income.
The state will add income back in that is not included in your federal AGI but is taxable on a state level. It will also subtract any items that are included in your federal taxes but are not taxed in Illinois, such as Social Security. You can visit the Illinois Department of Revenue website to learn more about these additions and subtractions.
Income Tax Exemptions & Credits
Tax Exemptions
Aligning with the state’s flat tax ideologies of simplicity and equality, Illinois does not allow itemized or standard deductions. You can, however, claim a personal exemption of up to $2,000, as of 2018. You might notice that this number is slightly lower than it was in years passed. This is because a law was recently passed that removed the personal exemption cost-of-living adjustment, which ensured that personal exemption limits steadily increased with the rising costs of living.
Tax Credits
In addition to personal exemptions, there are tax credits that can be filed to help reduce your taxable income. These include:
- Credits for those who work in Illinois but live in non-reciprocity states
- Property tax credits for those who own a primary residence in Illinois
- Education expense credits for those who have dependents or children enrolled in an Illinois school
- Earned income credits for low-income workers
Proposed Income Tax Changes
Right now, Illinois is only one of eight states that uses a flat income tax rate. Most other states use a progressive tax structure in which tax rates increase with income level. Essentially, the more money you make, the more income tax you pay.
As part of his 2018 campaign, Governor Pritzker promised to replace Illinois’ current flat tax rates with a progressive income tax system. To do so, an amendment to the Illinois Constitution would have to be made. In May of this year, both chambers passed a measure to repeal the flat tax and replace it with a progressive system.
Ratification of the amendment is ultimately up to Illinois voters, who will vote on the matter during the general elections in November 2020. A simple majority of all voters, including those who do not answer the question on their ballot, is required for it to pass.
What Would the New Income Tax Rates Be?
While the amendment would allow for a shift in Illinois’ current tax structure, it would not automatically increase or decrease tax rates. New tax rates are addressed in a separate bill, which has already passed in both chambers. Senate Bill 687, as it is known, would enact the following rate changes beginning January 1, 2021:
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First $10,000 for single and joint filers = 4.75%
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$10,000 to $100,000 for single and joint filers = 4.9%
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$100,000 to $250,000 for single and joint filers = 4.95%, the same as the current rate
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$250,000 to $350,000 for single filers and $250,000 to $500,000 for joint filers = 7.75%
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$350,000 to $750,000 for single filers and $500,000 to $1 million for joint filers = 7.85%
For example, let’s say that you and your spouse file jointly and have a total combined income of $300,000. The first $10,000 would be taxed at a rate of 4.75%, the next $90,000 at a rate of 4.9%, the next $150,000 at a rate of 4.95% and the final $50,000 at a rate of 7.75%. Instead of having your entire income subject to 7.75%, you pay a progressively higher rate each time you move to the next income level.
For single filers earning more than $750,000 and joint filers earning more than $1 million, the structure is slightly different. Taxpayers within this top tax bracket would have their entire net income subject to a rate of 7.99%.
While renegotiation of the bill seems unlikely, it is important to remember that these rates are not yet set in stone and could theoretically change between now and the 2020 general elections.
Who Would These Rates Affect Most?
At these currently agreed upon rates, anyone earning less than $250,000 would be subject to the same tax rate they are paying now, with a slightly lower rate on income under $100,000. This means that tax increases would only impact taxpayers earning more than $250,000, with those earning more than $750,000 (or $1 million jointly) taking the biggest hit.
How Would Illinois Compare to Other States?
Right now, 33 states and Washington D.C. operate under some kind of progressive tax system – while seven states have no income tax at all. Among those states that impose progressive income taxes, rates vary significantly. California tops the charts, with a maximum rate of 13.3% for taxpayers making more than $1 million per year. But about half of all progressive tax states have maximum rates hovering between 5-7%. This would put Illinois slightly above average, with a maximum rate of 7.99%.
So, What Should I Do Next?
The future of Governor Pritzker’s tax plan is still uncertain. And we will not know whether voters will ratify or reject the amendment until November of next year. That being said, the best thing you can do is assess how your income taxes might change if the amendment does go through. If you are making less than $250,000, go about your business as usual. Your tax rates will not change much, even if the amendment passes, so your current financial plan will remain largely unaffected.
But if you are bringing in more than $250,000 in annual income, we recommend that you speak with your financial advisor to determine what kind of impact these changes could have on your short- and long-term financial goals. As is always the case in financial planning, it is best to be prepared for any possibility, so you can adapt and put yourself on the best path toward financial success.