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updated: 8/2/2017 9:04 AM

How not taxing retirees' income costs Illinois

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  • Retirement income is exempt from the state income tax, regardless of whether the taxpayer is 65 years or not. And seniors 65 or older who are still working are still taxed by the state.

      Retirement income is exempt from the state income tax, regardless of whether the taxpayer is 65 years or not. And seniors 65 or older who are still working are still taxed by the state.
    Brian Hill | Staff Photographer, 2012

  • When legislators in July crafted the state's first budget in more than two years, they again excluded retirement income from state taxes. Taxing retirement income would have generated more than $2.7 billion in revenue for the state otherwise.

    When legislators in July crafted the state's first budget in more than two years, they again excluded retirement income from state taxes. Taxing retirement income would have generated more than $2.7 billion in revenue for the state otherwise.
    AP FILE PHOTO/2006

 
 

The newly increased 4.95 percent Illinois income tax will cost about $822 a year more for a family of three making $75,000.

But a retiree living off $75,000 in pension and Social Security income won't pay the state a thing.

That's because such income isn't taxed in Illinois, even if the person receiving it is under 65. The exemption will cost the state more than $2.7 billion a year, fueling some calls for Illinois to join the majority of states in taxing at least some retirement income.

The Illinois Department of Revenue, which provided that estimate, also reports nearly 1.6 million tax returns in 2015 -- a quarter of all returns filed -- claimed more than $54.7 billion in exempt income.

Taxing retirement income would increase general fund revenue by more than 8 percent, or it could provide tax reductions to the rest of the state's taxpayers, supporters say. But moves to tax retirement income have failed for a number of reasons.

"Because they vote," Bob Gallo, Illinois state director for the AARP, said of his group's membership. "It comes down to an affordability issue for many people and we let legislators know it."

Armed with a petition of 15,000 signatures and a survey showing 90 percent of members were against taxing retirement benefits, the state AARP chapter successfully lobbied legislators last year to keep that income free from taxes during the 2016 budget battle.

The survey also suggested a majority of respondents would consider moving out of state or have to re-enter the workforce if retirement income were taxed.

Income that isn't taxed includes public and private pensions, 401(k) withdrawals, annuities, Social Security payments and IRA withdrawals. All of those are taxed by the federal government.

Illinois does tax income earned by senior citizens, which puts the heaviest burden on those who must work because they lack other retirement resources, said Lourdes Holguin, a career coach specializing in senior employment at Lisle-based National Able Network. A $1,000 exemption for everyone 65 and older slightly reduces taxable income.

"It would make so much more sense to forgo taxing wages of working seniors because they've already contributed most, if not all, their lives," Holguin said. "They're back out there because of need, not because they want to, and they're penalized."

Illinois is one of 41 states with an income tax.

However, it is just one of three states, along with Mississippi and Pennsylvania, that exclude retirement income from that tax.

"By not, we're exempting big parts of the pie from the tax," said Daniel Hertz, a senior policy analyst for the Chicago-based Center for Tax and Budget Accountability.

Illinois initially taxed retirement income when an individual income tax was adopted in 1969. In 1971, legislators bowed to pressure from retirees and exempted any retirement income accrued before the tax was enacted.

A year later, state officials complained about the headache of computing what was exempt and suggested an outright exclusion for all retirement income.

State records show Harvard-educated Republican state Sen. Terrel E. Clarke of Western Springs warned the exemption would be very expensive and told colleagues it should end in 1980. Legislators ignored Clarke and voted almost unanimously to exempt retirement income in perpetuity.

In 1983, instead of adding retirement income back into the tax formula, the legislature increased the income tax rate from 2.5 percent to 3 percent.

The individual income tax rate was 3.75 percent until it was raised to 4.95 percent beginning July 1. It is expected to generate nearly $5 billion more a year for the state.

There was some debate about taxing retirement income when the legislature passed the most recent budget, state officials said.

"There was intense discussion about sources of revenue ... but I think Democrats, within their circle, there was not enough willingness to go down that path," said Arlington Heights Republican state Rep. David Harris.

Harris has two bills that call for taxing retirement income in some fashion.

Neither has gained traction, even though the bills set significant thresholds for taxation.

"The Department of Revenue told me there are 160 individuals in the state who receive more than $1 million a year in retirement income and they pay no taxes on that to the state," Harris said. "Why should someone who receives that much in retirement get a better deal than someone that age who still has to work and gets paid much, much less? This is about equity and fairness."

One of Harris' bills would tax anyone under 65 whose adjusted gross income with retirement income exceeds $80,000 and anyone 65 or older whose adjusted gross income with retirement income exceeds $100,000.

"That would still bring in a billion dollars in revenue," Harris said. "And that's at the old income tax rate of 3.75 percent."

Experts said one problem is the label of "retirement" income. Research suggests the majority of Illinois residents claiming the deduction aren't senior citizens.

"It's beyond frustrating because people can't have a sensible argument at all. It's all emotional," said Natalie Davila, a public finance economist for Springfield-based KDM Consulting and a former research director at the Department of Revenue. "It's got this label of retirement income, but it needs to be rebranded."

Davila wrote a report for the Taxpayers' Federation of Illinois in 2014 that said 60 percent of those who filed a return claiming retirement income deductions were under age 65. Police and firefighters, for instance, can receive full retirement benefits at age 50. The figure also includes anyone who borrowed from a 401(k), IRA or other private savings plans during the year.

"It's become the third rail of revenue (sources) because everyone says you're going to tax the little old lady with only $30,000 in retirement, but that's clearly not the case," Harris said.

Got a tip? Contact Jake at jgriffin@dailyherald.com or (847) 427-4602.

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