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Multistate Business Services: The Rules Changed - Did You File Your Illinois Return Correctly?

Most middle-market businesses have activity in more states than just Illinois. With Wisconsin and Indiana at both ends of the Tri-State Expressway, it is very easy for even a small business to conduct activity in three states. How the sale of services is sourced for apportionment purposes can drastically affect the tax liability for a company, and for Illinois-based companies there is potential to greatly reduce the amount of tax paid. Service companies such as law firms, architectural and engineering firms, and investment advisory or consulting firms should regularly review how they are sourcing revenue. In recent years states have started to move to sourcing sales based on where the benefit of the service is received; one such state is Illinois (for tax years ending on or after December 31, 2008).

Manufacturers who perform warranty/repair work or installation need to be cognizant of how service revenue is sourced as well. The manufacturer may need to apportion sales in two ways, one for the tangible personal property and another for services. Tangible personal property is sourced based on the property’s final destination. If it is a bundled transaction in which both tangible personal property and service are being received, then how the sale is sourced depends on the true object of the transaction. The true object is determined by ascertaining whether the customer's desire is to purchase the property component or the service component of the bundled sale.   For example, if a machine is sold, delivered and installed by the seller, typically the machine will be viewed as the true object of the sale. Thus, the sale would be sourced based on the tangible personal property rules.  However, if the machine breaks and repair work is completed with some parts installed, then the sale would be sourced based on the service rules of the state.  If the invoice is split between tangible personal property and services arguably each item is sourced based on its respective rules.

In general, services can be sourced in one of two ways with some modifications. The first method is referred to as the cost-of-performance method.  Sales are sourced to the state in which a majority (more than 50%) of the costs were incurred.  This method generally disregards the location where the service is received.  The other method for sourcing sales of services is the benefit-received method. This method sources the sale to the state in which the benefit of the service was received (i.e., where the customer is located and not where the services were performed). For tax years ending on or after December 31, 2008, Illinois switched from sourcing sales based on where the cost of performance occurred to where the benefit of the service was received. 

According to Illinois law, the gross receipts from the performance of a service are sourced to the state where the benefit was received and the customer has a fixed place of business. If the taxpayer cannot determine where the services should be sourced then the sale is thrown out of both the numerator and denominator of the sales factor for Illinois. If the taxpayer has NO nexus with the state in which the benefit was received, those sales also get thrown out.

There can be a big tax savings for companies that are located, and have a majority of their costs located in a benefit-received state such as Illinois. For example, if a consulting company in Illinois performs all of its services in Illinois but the customer is located in a cost-of-performance state such as Indiana, the gross receipts from the sales would not be sourced to either state and therefore no state tax would be paid, assuming the service provider had nexus with Indiana. Of course, the opposite could happen as well, where a sale is taxed in two states and this is why it is important to keep up to date on each state’s current legislation.

There are currently 10 states that source sales based on where the benefit was received, including many in the Midwest (Wisconsin, Ohio, Minnesota, Michigan, and Iowa), and the number is growing.

Because state tax laws constantly change, we recommend reviewing your apportionment methodology on a regular basis. Blackman Kallick’s State and Local Tax Group has the insight and experience to properly advise taxpayers on any of their issues or concerns.

For more information or to discuss any concerns regarding state taxation issues please contact Jason Parish at jparish@BlackmanKallick.com or 312-980-2959, or your Blackman Kallick representative. Our thanks to Deb Rood for her contribution to this article. 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.