I'm an Illinois resident who pays tax to other states -- why does my whole HSA deduction get subtracted from my out-of-state income on Schedule CR instead of just a proportional share?

Plain-English summary

An Illinois resident who pays income tax to other states wrote to the Department asking about the Schedule CR (Credit for Tax Paid to Other States) instructions for the Health Savings Account (HSA) deduction. The taxpayer noted that most deductions not specifically tied to out-of-state income -- like the deduction for one-half of self-employment tax -- are apportioned proportionally, so they only reduce the credit in the same ratio that out-of-state income bears to total income. That approach made intuitive sense to the taxpayer. But Schedule CR instead forces the entire HSA deduction to be treated as allocated against out-of-state income, with no proportional apportionment. The taxpayer pointed out that for someone with modest out-of-state income relative to total income, fully allocating the HSA deduction there can nearly wipe out the credit for taxes paid to those states, effectively causing double taxation on that income. The taxpayer also noted that the HSA deduction is taken against federal AGI (the starting point for Illinois income) and is not added back for general Illinois income purposes, so it seemed odd that residents with out-of-state income would effectively lose the benefit of it.

The Department held that the Schedule CR treatment is correct. The resident credit for taxes paid to other states under 35 ILCS 5/601(b)(3) is limited by a fraction: the numerator is the taxpayer's base income that would be allocated or apportioned to other states if those states had adopted Illinois's own Article 3 allocation and apportionment rules, and the denominator is the taxpayer's total base income subject to Illinois tax. The Department explained that in Lunding v. New York Tax Appeals Tribunal, 522 U.S. 287 (1998), the U.S. Supreme Court held that a state cannot discriminate against nonresidents by denying them the same deduction (there, alimony paid) that it allows its own residents. Because of Lunding, Illinois allows nonresidents to allocate the full amount of the HSA deduction to Illinois when determining their Illinois net income. The Department reasoned that, consistent with that same allocation principle, the credit limitation under Section 601(b)(3) must be computed by allocating the HSA deduction to other states as if those states followed Illinois's own allocation rules. On that basis, the Department concluded that the Schedule CR instructions "correctly apply the statute."

What the Department didn't do. The letter does not address or adopt the taxpayer's proportional-apportionment suggestion, and it does not create any carve-out for deductions -- like the HSA deduction -- that aren't tied to the source of the out-of-state income. As a GIL, it simply explains how the Department reads the existing statute in light of Lunding; it is not a statement of Department policy and does not bind the Department in any other case.

What this means for you

Illinois residents claiming the credit for taxes paid to other states

If you take an HSA deduction and also claim the Schedule CR resident credit for taxes paid to other states, expect the full amount of your HSA deduction -- not a proportional share -- to be treated as allocated against your out-of-state income when the credit limitation is computed. This can meaningfully shrink your credit if your out-of-state income is small relative to your total income.

Anyone comparing the HSA deduction to other Schedule CR deductions

Not every deduction is apportioned the same way on Schedule CR. Deductions not tied to a specific income source (like the one-half self-employment tax deduction) may be apportioned proportionally, but the HSA deduction is fully allocated to out-of-state income under this GIL's reasoning -- mirroring how Illinois lets nonresidents allocate their full HSA deduction to Illinois.

Accountants and tax professionals preparing Schedule CR

This GIL confirms the Department's position that the existing Schedule CR instructions on HSA deduction allocation are correct and traces that position to Lunding v. New York Tax Appeals Tribunal. Don't expect the Department to accept a proportional-apportionment argument for the HSA deduction based on this letter -- it treats full allocation to other states as compelled by the statute and case law, not as a matter of policy discretion.

Common questions

Q: Why is my whole HSA deduction allocated to out-of-state income instead of being apportioned proportionally like other deductions?
A: According to this GIL, it's because Illinois must allow nonresidents to allocate their full HSA deduction to Illinois (following Lunding v. New York Tax Appeals Tribunal), and the credit limitation fraction in 35 ILCS 5/601(b)(3) is computed by assuming other states would do the same -- so the full HSA deduction is allocated to those states' income in the fraction.

Q: Does this reduce my credit for taxes paid to other states?
A: It can. Because the entire HSA deduction is treated as reducing out-of-state income in the credit limitation calculation, a taxpayer with modest out-of-state income relative to total income may see the credit substantially reduced.

Q: What is Lunding v. New York Tax Appeals Tribunal and why does it matter here?
A: In Lunding, 522 U.S. 287 (1998), the U.S. Supreme Court held that a state cannot discriminate against nonresidents by denying them a deduction (there, alimony paid) that it allows residents. The Department applies that same reasoning to the HSA deduction to conclude that other states, if they followed Illinois's rules, would have to allow it in full -- which is why it belongs in the credit limitation's numerator.

Q: Is this letter binding on the Department for other taxpayers?
A: No. This is a General Information Letter, not a Private Letter Ruling. It does not constitute a statement of Department policy and is not binding on the Department.

Citations and references

Statutes and cases:

• 35 ILCS 5/601(b)(3) (resident credit for taxes paid to other states; credit limitation fraction)
• Lunding v. New York Tax Appeals Tribunal, 522 U.S. 287 (1998)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2023.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2023/it23-0012-gil.pdf

Original ruling text

IT 23-0012-GIL 07/11/2023 ALLOCATION
General Information Letter: In computing the credit for taxes paid to other states,
residents are required to allocate credits to out-of-state income due to the United
States Supreme Court decision in Lunding v. New York Tax Appeals Tribunal.
July 11, 2023
NAME
ADDRESS
Dear NAME:
This letter is in response to your letter in which you requested information about
taking certain deductions on Schedule CR. The Department issues two types of letter
rulings. Private Letter Rulings (“PLRs”) are issued by the Department in response to
specific taxpayer inquiries concerning the application of a tax statute or rule to a
particular fact situation. A PLR is binding on the Department, but only as to the taxpayer
who is the subject of the request for ruling and only to the extent the facts recited in the
PLR are correct and complete. Persons seeking PLRs must comply with the procedures
for PLRs found in the Department’s regulations at 2 Ill. Adm. Code 1200.110. The
purpose of a General Information Letter (“GIL”) is to direct taxpayers to Department
regulations or other sources of information regarding the topic about which they have
inquired. A GIL is not a statement of Department policy and is not binding on the
Department. See 2 Ill. Adm. Code 1200.120. You may access our website at
www.tax.illinois.gov to review regulations, letter rulings and other types of information
relevant to your inquiry.
The nature of your inquiry and the information you have provided require that we
respond with a GIL. In your letter you have stated and made inquiry as follows:

I would like to receive more information concerning the treatment of
Health Savings Account deductions as it pertains to IL-CR used when an
Illinois resident taxpayer pays taxes to other states. In apportioning the
deductions to either total IL income or specifically other state income,
most deductions that are not specifically related to the income in other
states are apportioned (like the ½ SE tax deduction) so that they are only
applied against other state income in a proportional manner. This
intuitively makes sense.
For the Health Savings Account deduction, however, the form
forces the ENTIRE HSA deduction to be applied against other state
income, rather than doing it in a manner proportional to the overall
percentage of income that the other states represented. For someone who
has modest income in other states compared to a large overall income,
this can almost entirely negate any income paid to other states, resulting
in an artificially lowered tax credit for taxes paid to those states and in
effect, double taxing that money. The HSA deduction is not specifically

NAME
Page 2
July 11, 2023
related to the income from other states as opposed to overall income, so it
is counter-intuitive that the entire deduction be levied against solely other
state income.
Would it be possible to explain why IL residents who pay taxes to
other states are not allowed the benefit of an HSA deduction, when it is
clearly the intent of the State of Illinois to allow a deduction for HSA
deductions for their residents in general, as the starting point for
calculating IL income is the Federal AGI, after the HSA deduction is
subtracted, and it is not added back in for general IL income?
Thank you in advance for any information you can provide.
DEPARTMENT’S RESPONSE:
Section 601(b)(3) of the Illinois Income Tax Act (35 ILCS 5/601) allows Illinois
residents a credit for taxes paid to other states. That section provides, in part:
[T]he credit provided under this paragraph for tax paid to other states shall
not exceed that amount which bears the same ratio to the tax imposed by
subsections 201(a) and (b) otherwise due under this Act as the amount of
the taxpayer's base income that would be allocated or apportioned to
other states if all other states had adopted the provisions in Article 3 of this
Act bears to the taxpayer's total base income subject to tax by this State
for the taxable year.
In Lunding v. N.Y. Tax Appeals Tribunal, 522 U.S. 287 (1998), the United States
Supreme Court held that states could not discriminate against nonresidents by denying
them the same deduction for alimony paid that would be allowed to residents.
Accordingly, Illinois allows nonresidents to allocate the full amount of the deduction for
health savings accounts to Illinois in determining their Illinois net income. Consistent
with this allocation, the limit on the credit for taxes paid to other states in Section
601(b)(3) must be computed by allocating the deduction for health savings accounts to
other states as if they followed the same allocation principles as Illinois. The instructions
to the Schedule CR, Credit for Taxes Paid to Other States, correctly apply the statute.
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.
I hope this information is helpful. If you require additional information, please
visit our website at www.tax.illinois.gov or contact the Department’s Taxpayer
Information Division at (217) 782-3336.

Very truly yours,

NAME
Page 3
July 11, 2023

Brian Fliflet
Deputy General Counsel