State Expects to Clear Backlog of Unpaid Income Tax Refunds in FY2013

September 06, 2012




Although the State of Illinois is still burdened with a multibillion-dollar backlog of unpaid bills, one component of that backlog—unpaid income tax refunds—is now expected to be eliminated at the end of FY2013.

The Illinois Department of Revenue projects that no approved refunds will be unpaid on June 30, 2013. That compares with $735 million owed at the end of FY2010 and only $70 million at year-end  FY2012. Currently, no approved refunds are owed, according to Revenue Department officials.

The following table shows unpaid individual income tax (IIT) refunds and business income tax (BIT) refunds from FY2008 to FY2012 and the projection for FY2013.

To understand the reduction, some background is needed on how the State pays refunds owed to taxpayers.

As discussed here, the State sets aside a percentage of income tax receipts received throughout the year and deposits them into a special fund. Different percentages apply to individuals and businesses, but all refunds are paid from the same fund, the Income Tax Refund Fund. The Department of Revenue makes it a priority to pay income tax refunds to individuals, so when there is a shortfall in the Refund Fund, unpaid business refunds rise.

The percentages applied to tax receipts are known as Refund Fund rates. The higher the Refund Fund rates, the more money deposited into the fund and the less revenue available for the State’s general operations. A higher rate also reduces the share of income taxes transferred to local governments. The Refund Fund rate for businesses covers both the income tax and the Personal Property Replacement Tax (PPRT) on corporations and the PPRT on subchapter S corporations, partnerships and estates.

As explained here, Refund Fund rates are set by the Illinois General Assembly or can be set through a statutory formula that takes into account both refunds paid and refunds approved but unpaid from the prior year as well as income tax revenues from the prior year. The last time the rate was set using the formula was FY1998. Since then it has been specifically designated in budget legislation passed by the General Assembly and signed by the Governor.

Despite the backlog of corporate refunds, the State lowered the Refund Fund rate for individual income taxes from 9.75% in FY2010 to 8.75% in FY2011 and kept the rate unchanged for FY2012. The business refund rate was held constant at 17.5%.

The Department of Revenue estimated a year ago that more than $1.7 billion in tax refunds would be paid to individuals in FY2012 and that the backlog of unpaid business tax refunds would total $594 million on June 30, 2012. Instead, tax refunds paid to individuals totaled less than $1.5 billion in FY2012.

The reason, according to the Department of Revenue, is that employers took a long time to adjust the amount of income tax withheld from workers’ pay to reflect the increase in the State income tax rate from 3% to 5% in January 2011. As a result, some individuals owed additional tax instead of receiving refunds. Because individual refunds were lower than expected, funds were available in the Refund Fund to pay down the backlog of business refunds.

The FY2013 budget raises the Refund Fund rate for individual income taxes to 9.75% and lowers the rate for business income taxes to 14.0%. The Department of Revenue expects all refunds approved and processed by the end of the fiscal year to be paid.

It should be noted that FY2013 receipts in the table above are projected to be below FY2012 levels. However, because wages and salaries have been higher than initially projected, the Department of Revenue plans to review the FY2013 estimate for individual income tax receipts after the fiscal first quarter ends on September 30, 2012. The Department of Revenue will also decide whether a revision of its FY2013 corporate income tax estimate is warranted.