If a former employee moved out of Illinois before receiving a back-pay settlement for wages earned while she worked in Illinois, does the employer still have to withhold Illinois income tax from that payment?

Subject

Non-Resident Withholding

Plain-English summary

An employer asked the Illinois Department of Revenue whether it was right to withhold Illinois income tax from a settlement payment of back wages made to a former employee. The employee had worked at the employer's Illinois airport location, but by the time the settlement check was issued, she had moved out of Illinois and notified the company of her new out-of-state address. She argued that because she no longer lived or worked in Illinois when the money was actually paid, the back wages shouldn't be subject to Illinois tax.

The Department disagreed with the employee and sided with the employer's existing practice. Under IITA Section 302(a), compensation paid to a nonresident is allocated to (and taxed by) Illinois if it was "paid in" Illinois, and under 86 Ill. Adm. Code 100.3100(d), pay for past services still counts as compensation even after the employment relationship has ended, "so long as such relationship existed when the services were rendered." Because the back wages were compensation for work the employee performed while she was an Illinois-based employee, they are treated as paid in Illinois and allocable under 86 Ill. Adm. Code 100.3120(a)(1) — regardless of where she was living when the check was cut.

The Department also leaned on federal case law holding that back pay and severance paid to former employees are still "wages" subject to withholding, even when the employee no longer performs services for the employer at the time of payment: United States v. Quality Stores, Inc. (severance pay is wages for Social Security tax purposes) and Noel v. New York State Office of Mental Health Central New York Psychiatric Center (a jury's back-pay and front-pay award to a former employee was wages subject to withholding).

This is a General Information Letter (GIL), not a Private Letter Ruling. That means it is explicitly not binding on the Department and is not a statement of Department policy — it merely explains how the relevant statutes and rules apply based on the facts described. If the former employee wants to dispute the withholding, the letter notes she would need to file a timely refund claim (governed by IITA Section 911(a)) and, if denied, protest that denial through the process the Department would describe in the denial notice.

What this means for you

Employers and payroll professionals

If you pay back wages, severance, or a settlement to a former employee for work they performed while employed in Illinois, this letter indicates you should generally continue treating that payment as Illinois-source compensation and withhold Illinois income tax accordingly — even if the employee has since moved out of state and notified you of a new address. The Department described this as consistent with the employer's "longstanding policy, interpretation and implementation of state tax regulations" in the underlying facts, and it agreed with that treatment.

HR and benefits staff handling terminated employees who moved out of state

An employee's current address or residency at the time a settlement or back-pay check is issued does not, by itself, change how the payment is sourced for withholding purposes. The letter is explicit: the back wages "are therefore allocable... and subject to Illinois income tax regardless of the former employee's residence at the time of payment." What matters is where the employee was working when the underlying services were performed, not where she lived when she cashed the check.

Terminated employees and accountants advising them

If you believe Illinois withholding was applied incorrectly to a settlement or back-pay payment, this letter notes the avenue is a refund claim, not simply disputing the withholding after the fact. Under IITA Section 911(a), a refund claim generally must be filed within 3 years of when the return was filed (or, for amounts withheld, within 3 years of the 15th day of the 4th month following the close of the calendar year in which the withholding occurred), or one year after the tax was paid, whichever is later. If the claim is denied, the taxpayer can then protest that denial.

Common questions

Q: Does moving out of Illinois before a settlement is paid make back wages exempt from Illinois withholding?
A: No. The Department ruled that where the pay came from — services performed while the employee was Illinois-based — controls, not where she lived when the payment was actually made.

Q: Does it matter that the employee was no longer employed by the company when the settlement was paid?
A: No. 86 Ill. Adm. Code 100.3100(d) and the federal cases cited in the letter (Quality Stores, Noel v. NYS OMH) all confirm that compensation for past service is still "compensation"/"wages" subject to withholding even after the employment relationship has ended, as long as the relationship existed when the underlying services were performed.

Q: How far back does Illinois look to decide if the pay was earned in Illinois?
A: The letter cites 86 Ill. Adm. Code 100.3120(c)(1), which presumes that compensation paid for past service was earned ratably over the employee's last 5 years of service with the employer, unless shown to be properly attributable to a different period.

Q: Can the former employee do anything if she disagrees with the withholding?
A: The letter says she would need to timely file a refund claim under IITA Section 911(a), and if that claim is denied, protest the denial in the manner the Department explains in its denial. The GIL doesn't resolve that dispute itself — it only addresses whether the withholding was proper in the first place.

Q: Is this letter binding on the Department or on other taxpayers?
A: No. It is a General Information Letter, which by regulation (86 Ill. Adm. Code 1200.120(b) and (c)) is designed to provide general information, is not a statement of Department policy, and is not binding on the Department. The letter itself also notes that the requester could pursue a binding Private Letter Ruling instead by submitting the information required under Section 1200.110(b), if not currently under audit.

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2021.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2021/it21-0012-gil.pdf

Original ruling text

IT 21-0012 11/23/2021 NON-RESIDENT WITHHOLDING
Withholding of Illinois income tax required for Compensation paid to a
nonresident for services performed in Illinois.
November 23, 2021
Re: Illinois income tax
Dear NAME:
This is in response to your letter dated May 19, 2021, in which you request
information regarding Illinois income tax. The nature of your request and the
information you have provided require that we respond with a General
Information Letter, which is designed to provide general information, is not a
statement of Department policy and is not binding on the Department. See 86 Ill.
Adm. Code 1200.120(b) and (c), which may be found on the Department's web
site at www.tax.illinois.gov.
Your letter states as follows:
We hereby request a private letter ruling regarding taxation of a settlement
payment to an Employee for back pay.
The Employee was terminated on DATE and was working at the BUSINESS
airport location as a COMPANY Employee. Her permanent address at the
time of termination was CITY, STATE.
On DATE, she notified COMPANY that her address had changed to CITY,
STATE.
On DATE she received a settlement check that included back wages. She
was taxed for Illinois State Income Tax since we considered her back wages
to be derived from her service in Illinois, as this has been our longstanding
policy, interpretation and implementation of state tax regulations. She is
claiming that since she was no longer employed or living in Illinois at the
time of settlement pay that her back wages should not be subject to Illinois
tax.
Please respond with your ruling as to whether her wages were or were not
subject to Illinois State Income Tax.
RULING
Regarding the allocation of compensation paid to nonresidents for Illinois income
tax purposes, Section 302(a) of the Illinois Income Tax Act (“IITA”; 35 ILCS
5/302) provides:
All items of compensation paid in this State (as determined under Section
304(a)(2)(B)) to an individual who is a nonresident at the time of such
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payment and all items of deduction directly allocable thereto, shall be
allocated to this State.
IITA Section 1501(a)(3) defines the term “compensation” to mean wages,
salaries, commissions and any other form of remuneration paid to employees for
personal services. The Illinois Administrative Code further describes the
statutory definition of compensation in 86 Ill. Adm. Code 100.3100(c):
The name by which remuneration for services is designated is immaterial.
Thus, salaries, fees, bonuses, commissions on sales or on insurance
premiums, and pensions and retired pay are compensation within the
meaning of the statute if paid for services performed by an employee for
his employer.
86 Ill. Adm. Code 100.3100(d) states:
Remuneration for personal services constitutes compensation even
though at the time paid the relationship of employer and employee no
longer exists between the person in whose employ the services were
performed and the individual who performed them, so long as such
relationship existed when the services were rendered.
Pursuant to these provisions, back pay must generally be considered
“compensation” for purposes of the IITA. As such, back pay is taxable in Illinois if
“paid in this State” under IITA Section 302(a).
86 Ill. Adm. Code 100.3120(a)(1) states that compensation is paid in Illinois if:
A)

The individual's service is localized in Illinois because it is
performed entirely within Illinois (IITA Section 304(a)(2)(B)(i));

B)

The individual's service is localized in Illinois although it is
performed both within and without Illinois, because the service
performed without Illinois is incidental to the individual's service
performed within Illinois (see IITA Section 304(a)(2)(B)(ii)); or

C)

For taxable years ending prior to December 31, 2020, the
individual's service is not localized in any state under subsections
(a)(1)(A) and (B), but some of the service is performed within Illinois
and either:
i)

the base of operations, or if there is no base of operations,
the place from which the service is directed or controlled is
within Illinois; or

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ii)

the base of operations or the place from which the service is
directed or controlled is not in any state in which some part
of the service is performed, but the individual's residence is
in Illinois. (See IITA Section 304(a)(2)(B)(iii).)

D)

The rules in subsections (a)(1)(A) through (C) are to be applied in a
manner so that, if they were in effect in other states, an item of
compensation would constitute compensation "paid in" only one
state. Thus, if an item would, under these rules, constitute
compensation paid in a state other than Illinois because the
individual's service was localized in that other state under
subsection (a)(1)(B), it could not also be compensation paid in
Illinois.

E)

For taxable years ending on or after December 31, 2020, the
individual's service is not localized in any state under subsection
(a)(1)(A) or (B), but some of the individual's service is performed
within this State and the individual's service is performed within this
State for more than 30 working days during the taxable year, the
amount of compensation paid in this State shall include the portion
of the individual's total compensation for services performed on
behalf of his or her employer during the taxable year that the
number of working days spent within this State during the taxable
year bears to the total number of working days spent both within
and without this State during the taxable year. (IITA Section
304(a)(2)(B)(iii))…

In your letter you state that the former employee “was taxed for Illinois State
Income Tax.” For the purposes of this GIL, it will be assumed that you mean that
COMPANY withheld Illinois state taxes from the back wages. If that assumption
is correct, then COMPANY’s treatment of the former employee’s back wages as
derived from her service in Illinois, and withholding appropriate taxes, is
consistent with federal case law.
In United States v. Quality Stores, Inc., 134 S. Ct. 1395 (2014), the United States
Supreme Court held that severance pay made to employees who were
terminated as the result of the employer’s bankruptcy constituted wages subject
to Social Security taxation. The Court noted that Section 3121(a) of the Internal
Revenue Code defines wages as “all remuneration for employment, including the
cash value of all remuneration (including benefits) paid in any medium other than
cash” and that Section 3121(b) of the Internal Revenue Code provides that
“employment” encompasses “any service, of whatever nature, performed by an
employee for the person employing him.”. The Court stated that the term
“service,” used with respect to Social Security, “means not only work actually
done but the entire employer-employee relationship for which compensation is
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paid to the employee by the employer.” This principle goes back to the decision
in Social Security Bd. v. Nierotko, 327 U. S. 358 (1946), which held that “wages”
in the Social Security context to apply to damages paid by a business to a former
employee, who had been wrongfully terminated.
In Noel v. New York State Office of Mental Health Central New York Psychiatric
Center, 697 F.3d 209 (2d Cir. 2012), the court held that a jury award to a former
employee constituted wages subject to withholding. In that case, Noel had been
terminated from his job at the Central New York Psychiatric Center. Prior to his
termination, he had cooperated in a formal investigation of race discrimination by
his supervisors, and he brought a retaliation claim arising from this episode. The
jury awarded him $210,000 in back pay and $70,000 in front pay, plus damages
for emotional distress, which were disallowed on appeal. The Second Circuit
court held that the back pay and front pay were wages subject to federal and state
withholding.
In all of these cases, the courts found it irrelevant that the employee was no
longer employed by the former employer at the time the payments were made,
and that the employee actually performed no services for the employer in direct
exchange for the payments. Under this case law, the amounts received by your
former employee are properly designated as wages, even though her
employment terminated before the payments were made.
86 Ill. Adm. Code 100.3120(c)(1) states, in pertinent part, as follows:
…For the purpose of determining whether and to what extent
compensation paid for past service is "paid in" Illinois and is allocated to
Illinois under IITA Section 302(a), that compensation is presumed to have
been earned ratably over the employee's last 5 years of service with the
employer…properly attributable to a different period of employment or that
it was not earned ratably over the appropriate period of employment.
Compensation earned in each past year will be deemed compensation
paid in Illinois if the individual's service in that year met the tests set forth
in [100.3120(a)] applicable to that year…
In this case, the back wages paid to your employee were compensation for
services performed during a period in which she was an Illinois based employee
and were based on that employer relationship. Accordingly, the back wages are
properly characterized as wages to which she was entitled as the result of
employee services performed prior to her termination. They are therefore
allocable under Section 304(a)(2)(B) of the Illinois Income Tax Act and 86 Ill.
Adm. Code 100.3120(a)(1), and subject to Illinois income tax regardless of the
former employee’s residence at the time of payment.
If your former employee wishes to contest the Department’s determination of her
liability and preserve her right to a refund of any overpayment, she must timely
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file a refund claim and, if the claim is denied, protest the denial in the manner that
will be explained in the denial.
Section 911(a) of the Illinois Income Tax Act, 35 ILCS 5/911(a) provides:
(a) In general. Except as otherwise provided in this Act:
(1) A claim for refund shall be filed not later than 3 years after the
date the return was filed (in the case of returns required under Article 7 of
this Act respecting any amounts withheld as tax, not later than 3 years
after the 15th day of the 4th month following the close of the calendar year
in which such withholding was made), or one year after the date the tax
was paid, whichever is the later; and
(2) No credit or refund shall be allowed or made with respect to the
year for which the claim was filed unless such claim is filed within such
period.
Further guidance on when compensation is considered “paid in this State” and
subject to withholding, can be found at 86 Ill. Adm. Code Section 100.7010,
which can be found at:
http://www.ilga.gov/commission/jcar/admincode/086/086001000S70100R.html
and in Publication 130, which can be found at:
https://www2.illinois.gov/rev/research/publications/pubs/Documents/pub-130.pdf
As stated above, this is a general information letter which does not constitute a
statement of policy that applies, interprets or prescribes the tax laws, and it is not
binding on the Department. If you are not under audit and you wish to obtain a
binding Private Letter Ruling regarding your factual situation, please submit all of
the information set out in items 1 through 8 of Section 1200.110(b). If you have
any further questions regarding this letter, you may contact me at (217) 7822844.
Sincerely,
Michael D. Mankowski
Associate Counsel - Income Tax
cc:

Daily File
Correspondence file:

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