Bloomberg Tax
Sept. 11, 2020, 8:01 AM

INSIGHT: Destined for the Courtroom—Illinois Audit Program Won’t Stop Sales Tax Litigation

Breen Schiller
Breen Schiller
Eversheds Sutherland (US) LLP
Dennis Jansen
Dennis Jansen
Eversheds Sutherland (US) LLP

The Illinois Department of Revenue (IDOR) recently announced an expansion of its Audit Fast Track Resolution (FTR) Program to all sales and miscellaneous tax audits except for Motor Fuel Use Tax. The expansion of the FTR program to sales taxes comes as the IDOR braces for a wave of litigation regarding the state’s problematic new amendments to its marketplace facilitator law. The newly-expanded FTR program could become an efficient method of settling some sales tax disputes, but disagreements involving the state’s amended marketplace facilitator law will ultimately need to be resolved by legislature or courts.

The Audit Fast Track Resolution Program

Announced as a pilot program in December 2018, the FTR provides a forum for the prompt resolution of disputed audit issues while a case is still under the jurisdiction of the IDOR’s Audit Bureau. The believed impetus for the program was the reluctance of many auditors to settle issues within their authority at the audit level, such as penalty abatement. This practice resulted in a years-long backlog at the IDOR’s Board of Appeals due to cases involving issues that could have been resolved by the Audit Bureau.

The FTR Program is a discretionary venue for taxpayers to settle or mediate issues prior to the Audit Bureau’s issuance of a notice of proposed liability. A FTR Facilitator serves as a neutral mediator between the taxpayer and the IDOR, and oversees settlement negotiation during or prior to the FTR Conference. This potentially valuable mediation program is limited in scope and time because the FTR Program only covers the resolution of issues based upon the audit record, and the entire process is to be completed within 60 days of a taxpayer’s filing of a FTR application.

Taxpayers who choose to go through the FTR Program retain their statutory review, protest, and appellate rights. However, a confidentiality agreement is part of the FTR application process, thereby preventing any FTR Program discussions, offers, or proposed adjustments from being used in subsequent proceedings at the Informal Conference Board, Independent Tax Tribunal, or in court.

When announced in 2018, the FTR Program was only available to certain “cash businesses” that also fell under specific business types identified by their Standard Industrial Classification and North American Industry Classification System codes. The expansion announced the IDOR’s September Information Bulletin opens to the program to all sales and miscellaneous tax audits. The expansion may help clear a number of pending sales tax cases ahead of an anticipated avalanche of new disputes caused by Illinois’ confusing amendments to its marketplace facilitator law.

Illinois’ Marketplace Facilitator Law

Like many states, Illinois enacted a marketplace facilitator sales tax collection law after the 2018 Wayfair decision. The goal of this law was to “level the playing field” between online and in-store sales by requiring marketplace facilitators and remote retailers to collect sales tax. However, the law did not completely level the playing field because it failed to account for local sales taxes. A legislative “fix” which goes into effect on Jan. 1, 2021, does not remedy the problem, but instead creates additional confusion for retailers and consumers by imposing different sales tax rates and sourcing rules on comparable sales.

Illinois sales tax is comprised of two complimentary taxes: the Retailers’ Occupation Tax (ROT) which is imposed on sellers of tangible personal property, and the Use Tax (UT) which is imposed on purchasers of tangible personal property. Both taxes are 6.25% at the state level. Purchasers are required to pay UT to retailers, which reimburses the retailers for ROT. Illinois requires remote marketplace facilitators and sellers to collect UT on behalf of purchasers if the seller meets the state’s economic nexus threshold of $100,000 in annual sales or 200 separate transactions. However, these sellers are not required to collect local ROT, and only one jurisdiction (Chicago) imposes a local UT. Therefore, Illinois’ marketplace law fails to “level the playing field” between online and in-store sales because of the applicability of local sales tax.

To remedy this, the Illinois General Assembly passed S.B. 690, which introduces new complexity in determining the proper taxation of online sales:

  • Online retailers with only economic (rather than physical) presence in the state are subject to state and local ROT based on the Illinois customer location (destination sourcing).

  • Online retailers with physical presence in Illinois but no brick-and-mortar stores must still charge 6.25% UT to customers except when the sale is fulfilled by an Illinois warehouse. In that case, the retailers must charge the state and local ROT rate applicable to the warehouse location.

  • Online retailers with a brick-and-mortar Illinois store must charge the state and local ROT rate in effect at the store location (origin sourcing).

  • Online retailers that do not meet the state’s economic nexus thresholds are not required to collect tax.

Additionally, marketplace facilitators are deemed to be the retailers of all sales made through their platforms. However, affiliates of a marketplace facilitator are not considered “marketplace sellers” when making sales on an affiliated marketplace due to provisions in another marketplace “fix” bill, S.B. 119.

Can the FTR Program Handle the Inevitable Disputes?

The impending changes to Illinois’ marketplace facilitator tax collection obligations can lead to unexpected results and perceived tax-motivated behavior. For example, the sourcing of an online sale may shift based on a factor unrelated to the transaction, such as an employee that recently relocated to Illinois, thereby creating a physical presence for the online seller:

  • An online retailer without any physical presence in the state, but meets one of the two economic nexus thresholds, may have to collect ROT based on the destination of customers.

  • Meanwhile, a relocating employee could create an Illinois physical presence for the retailer, requiring the collection of UT, but not local taxes.

  • Conversely, if the sale is fulfilled from a warehouse in Illinois, the ROT is due based on the location of the warehouse.

Some retailers may want to create a physical presence within the state to be eligible for the 6.25% UT rate rather than figuring out the applicable ROT rate for each customer location. Other retailers may not be able to properly determine the tax rules that apply to a sale if their inventory is fulfilled by a third-party with locations within Illinois. Furthermore, numerous sales tax systems are not capable of handling the varying factors that are required to determine the applicable Illinois sales tax. This will certainly lead to more sales tax disputes that may be ripe for the FTR Program.

IDOR officials have acknowledged that the differing sourcing rules in Illinois’ marketplace law may pose issues under the U.S. and Illinois constitutions. Despite these concerns, IDOR’s only response so far has been to provide charts to guide taxpayers on the relevant tax types and rates. Given the historical reluctance of IDOR auditors to resolve issues within their authority, it is highly unlikely that the FTR Program will successfully mediate many major challenges regarding the constitutionality of its marketplace facilitator law. Therefore these disputes seem destined for the courtroom unless another legislative “fix” materializes.

Author Information

Breen Schiller is a partner in the Chicago office of Eversheds Sutherland (US) LLP. She focuses her practice on complex state and local tax planning, audit defense, and the litigation of sophisticated multi-state and local tax issues.

Dennis Jansen is an associate at Eversheds Sutherland (US) LLP based in Dallas, Texas. He represents clients in all stages of tax controversy and advises on multistate tax planning and complex transactions.