Rockwood Holding Co. v. Department of Revenue

• Court: Appellate Court of Illinois
• Citation: Rockwood Holding Co. v. Department of Revenue, 312 Ill. App. 3d 1120, 728 N.E.2d 519, 245 Ill.Dec. 437 (Ill. App. 2000)
• Decision Date: 24 March 2000
• Docket Number: No. 1-98-4081.,1-98-4081.
• Parties: ROCKWOOD HOLDING COMPANY, Plaintiff-Appellant, v. The DEPARTMENT OF REVENUE, Defendant-Appellee.

728 N.E.2d 519

312 Ill. App.3d 1120

245 Ill.Dec. 437

ROCKWOOD HOLDING COMPANY, Plaintiff-Appellant, v. The DEPARTMENT OF REVENUE, Defendant-Appellee.

No. 1-98-4081.

Appellate Court of Illinois, First District, Sixth Division.

March 24, 2000.

Diane M. Anderson, Neal, Gerber & Eisenberg, Chicago, for Appellant.

Joel D. Bertocchi, Solicitor General, Attorney General Office, Chicago, for Appellee.

Justice BUCKLEY delivered the opinion of the court:

Defendant, Illinois Department of Revenue (Department), assessed plaintiff, Rockwood Holding Company, with underpayment of its 1986 Illinois income taxes. Plaintiff protested the assessment, but after a hearing, the Department rejected the challenge. Then, pursuant to the Administrative Review Law (735 ILCS 5/3-101 (West 1994)), plaintiff filed a verified complaint in the circuit court of Cook County. The circuit court affirmed the Department's decision and this timely appeal followed.

On appeal, plaintiff asserts that its 1986 income has been overstated by more than $1,500,000 because its 1984 loss, which was deductible for federal purposes, was not deductible for Illinois purposes. Specifically, plaintiff seeks reversal of the circuit court's decision and contends that (1) it is entitled to alternative relief under section 304(f) of the Illinois Income Tax Act (the Act) (35 ILCS 5/101 et seq. (West 1992)); (2) its income must be adjusted so that only the net income will be taxed; (3) if the Act does not allow for any adjustment, then defendant's overstatement of plaintiff's taxable income violates the uniformity clause of the Illinois Constitution (Ill. Const. 1970, art. IX, § 2) and the due process clause of the United States Constitution (U.S. Const., amend. XIV, § 1); and (4) the penalties imposed on plaintiff should be abated for reasonable cause. For the reasons set forth below, we affirm.

FACTS

The underlying facts are undisputed. Plaintiff is a holding company incorporated in Delaware and authorized to do business in Illinois that owns companies in the business of investing and real estate. In 1984, plaintiff became a 50% general partner in the Caster-Rockwood Partnership (Partnership). The Partnership was formed as part of a financing arrangement for the Midland-Ross Corporation. The sole function of the Partnership was to purchase 1,360,000 shares of Midland-Ross preferred stock for $33.50 per share and hold the stock for two years. After the two-year period, the Partnership was to sell the stock back to Midland-Ross for at least $41.71 per share. The transaction went ahead as planned. The Partnership borrowed $45,560,000 and purchased the stock in 1984. In 1986, Midland-Ross redeemed the stock for $65,497,600. The Partnership paid off the loan, distributed profits to the partners and then dissolved.

In 1984, the Partnership suffered a net loss because its dividend income was less than its interest expense on the money borrowed to purchase the stock. Plaintiff's share of the loss was $1,724,388 and its business income apportionable to Illinois was $64,424 in 1984. As a result, plaintiff's net income was ($1,659,964)¹ and it did not pay taxes in 1984 under the Act. However, when the stock was redeemed in 1986, the Partnership realized profits of $9,820,775.² Plaintiff offset that income by deducting the amount of the 1984 partnership loss on its 1986 tax return. After an audit, plaintiff's partnership income was adjusted upward by the Department from ($110,021) to $9,710,754, and it was determined that plaintiff owed an additional $525,880 in taxes, penalties and interest. The Department issued a notice of deficiency, and plaintiff filed a timely protest and request for a hearing.

At the hearing, plaintiff maintained that it should be allowed to deduct the 1984 partnership loss from its 1986 income. Specifically, plaintiff argued that section 201 of the Act only allows a tax on "net income," but in the event that an offset was not required by section 201, it was entitled to relief under section 304(f) of the Act. See Ill.Rev.Stat.1985 ch. 120, pars. 2-201(a), 3-304(f). The administrative law judge (ALJ) issued a recommendation for disposition rejecting plaintiff's argument on the basis that "carryforward or carryback of this negative amount was not permitted because there was no provision in the [Act]" during the time relevant to this case. The Department, therefore, upheld its position, and plaintiff filed a verified complaint for administrative review in the circuit court of Cook County. The circuit court issued an order affirming the Department's conclusion on the merits and subsequently entered judgment in the Department's favor on September 29, 1998, in the amount of $596,737 for $246,661 in underpaid taxes, $232,043 in interest and $118,033 in penalties. This appeal followed.

ANALYSIS

We should first note that the parties to this appeal do not present any factual disputes; only the legal issues are in controversy. Consequently, we are not bound by the administrative agency's conclusions of law or statutory construction and we will review those decisions de novo. See Raintree Health Care Center v. Illinois Human Rights Comm'n, 173 Ill.2d 469, 479, 220 Ill.Dec. 124, 672 N.E.2d 1136, 1141 (1996). However, we do recognize that Illinois courts may defer to an administrative agency's interpretations and enforcement of statutes because of the considerable experience and expertise it may have concerning the issues before it. Bonaguro v. County Officers Electoral Board, 158 Ill.2d 391, 398, 199 Ill.Dec. 659, 634 N.E.2d 712 (1994), citing Abrahamson v. Illinois Department of Professional Regulation, 153 Ill.2d 76, 97-98, 180 Ill. Dec. 34, 606 N.E.2d 1111 (1992).

I

The starting point for taxation in Illinois is section 201(a) of the Act, which is titled "[t]ax imposed" and states in relevant part: "A tax measured by net income is hereby imposed on every individual, corporation, trust and estate * * * on the privilege of earning or receiving income in or as a resident of this State." Ill.Rev. Stat.1985, ch. 120, par. 2-201(a).³ The Act defines "net income" in section 202 as "that portion of [the taxpayer's] base income for such year * * * which is allocable to this State * * * less the standard exemption allowed by Section 204 and the deduction allowed by Section 207." Ill. Rev.Stat.1985, ch. 120, par. 2-202(a). "[B]ase income," for the purposes of a corporation, is "an amount equal to the taxpayer's taxable income for the taxable year." Ill.Rev.Stat.1985, ch. 120, par. 2-203(b)(1).⁴ And "taxable income" is "income properly reportable for federal income tax purposes for the taxable year under the provisions of the Internal Revenue Code." Ill.Rev.Stat.1985, ch. 120, par. 2-203(e)(1). Therefore, the Act "piggy-backs" onto the federal calculation of income and uses federal taxable income as the premise for tax liability. See Kraft, Inc. v. Sweet, 213 Ill.App.3d 889, 891, 157 Ill.Dec. 320, 572 N.E.2d 389, 390 (1991),appeal denied, 141 Ill.2d 543, 162 Ill.Dec. 491, 580 N.E.2d 117 (1991); see also Taxation Today, Dept. of Rev. Newsltr., par. 400-236, at 22, 430-32 (C.C.H.) (Spring 1987).

If the taxpayer is a corporation, then it is a nonresident for allocation and apportionment purposes. See Ill.Rev.Stat. 1985, ch. 120, pars. 15-1501(a)(14), (a)(20).⁵ For nonresidents, allocation and apportionment depends upon whether the income is "nonbusiness income" or "business income." See Ill.Rev.Stat. 1985, ch. 120, pars. 3-302, 3-303, 3-304. This distinction between the two types of income exists in the Act but has no analog under federal tax law. Once income is allocated or apportioned under the Act, the standard exemption is subtracted (section 204), yielding the taxpayer's net income, which is then multiplied by the tax rate.

In the case at bar, plaintiff asserts that it should not have to pay the judgment entered by the circuit court because its actual income was overstated by more than $1,500,000. This alleged distortion in plaintiff's income was apparently the result of the 1984 partnership loss being deductible for federal purposes, but not for Illinois purposes. As a result, the 1984 loss was trapped in 1984 and could not be carried forward to 1986. The subsequent amendment of the Act in 1985 would have allowed plaintiff's loss to be carried forward in a manner similar to the Internal Revenue Code (IRC). See Ill.Rev.Stat. 1987, ch. 120, par. 2-207; Pub. Act 84-1042, eff. November 26, 1985; 26 U.S.C. § 172 (1988). However, the new version of the Act did not apply to losses "carried forward from a taxable year ending prior to December 31, 1986." Ill.Rev.Stat.1985, ch. 120, par. 2-203(b)(2)(D). Plaintiff, therefore, insists that since the Illinois General Assembly recognized the unfairness of the Act and corrected the inconsistency, it should not be responsible for the tax liability that resulted from the stock purchase-sale transaction. We will now address each specific argument in turn.

II

Plaintiff first contends that the General Assembly could have never intended the result sought by the Department. Specifically, plaintiff refers to sections 304(f) and 102 of the Act and argues that each provides the alternative relief necessary to reach a fair result.

A

Section 304(f) of the Act allows for an "alternative allocation" of business income to Illinois if "the allocation and apportionment provisions of subsections (a) through (e) [of section 304] do not fairly represent the extent of a person's business activity." Ill.Rev.Stat.1985, ch. 120, par. 3-304(f). To proceed under this section, the taxpayer may petition the Department for, or the Department may require, "[t]he employment of any other method to effectuate an equitable allocation and apportionment of the person's business income." Ill.Rev. Stat.1985, ch. 120, par. 3-304(f)(4).

Both the Department and the circuit court rejected this argument. The ALJ's recommendation stated that section 304(...