The RTA filed suit today in the Circuit Court of Cook County to recoup more than $100 million of revenue lost to tax avoidance scams operating in the municipalities of Kankakee and Channahon. The lawsuit arises from the utilization of tax sharing agreements which have induced companies operating within the six-county RTA region and across the State to claim that their sales are sourced through sham offices set up in Kankakee and Channahon. Under these agreements, the two municipalities kick back almost the entire amount of their local share of the statewide sales tax to participating companies. These companies do not create jobs, promote economic development or have any operations in Kankakee or Channahon. The suit further alleges that the municipalities have disregarded the Freedom of Information Act (FOIA) by denying the RTA’s request for the release of the agreements. Kankakee and Channahon also refuse to disclose the names of the participating companies to whom they paid more than $30 million of public funds in 2010.
“The RTA system relies on sales tax revenue for almost 50% of our funding,” said RTA Executive Director Joe Costello. “It is this funding that keeps our trains and buses running and in good repair. We know that these illegal tax avoidance scams are costing our riders tens of millions in lost revenues every year.”
At the heart of the suit is the issue of where a sale is “sourced.” Unlike most states, Illinois imposes its sales tax at the location where the seller operates its business, not the location where the buyer is. The distinction doesn’t matter when a sale is made over-the-counter, because the sale is simply sourced at the store. If the buyer and seller are at different locations when a sale happens, however, the sourcing rules matter a lot. They determine not just the rate of sales tax that applies, but also which local government gets a portion of the tax collected.
All sales in Illinois are taxed at a minimum of 6.25%, of which 5% goes to the state and the remainder goes to the location where the sale is sourced: 1% to the municipality and .25% to the county (in Cook County, that 25% goes to the RTA).
Additionally, home rule units of government may impose additional tax on sales which are sourced within their boundaries, and the Illinois General Assembly imposed a special sales tax in the six-county RTA region to fund public transit. The effect of this tax policy is a 9.75% rate in Chicago, rates between 8.25-9.5% in suburban Cook County, and between 7-8% in most of the collar counties of DuPage, Kane, Lake, McHenry and Will.
The difference in sales tax rates occasionally leads a company to relocate, and in Illinois a municipality is allowed to compete for that business by offering to share sales tax revenues if the company moves inside its borders. When a municipality offers to share public money with a company that only pretends to relocate, however, it is breaking the law. Legislation passed in 2004 forbids any municipality from entering into a tax sharing agreement with a company if that company isn’t engaged in any legitimate business within the municipality and should be rightfully paying its taxes to another local government.
Aggressive tax consultants have set up shop in Kankakee and Channahon to provide a local address and phone number to businesses that actually operate in other cities around the state, including places like Chicago, Peoria, Champaign and Springfield. The typical consulting office is staffed by a single person, who forwards phone calls, faxes and mail on to final destinations outside of Kankakee and Channahon on behalf of multiple companies, without performing any meaningful selling activity as required under Illinois sales tax sourcing rules. In exchange for falsely claiming that their sales were made by these do nothing consultants, participating companies are rewarded with 75-85% of the revenues that Kankakee and Channahon misappropriate from other local governments, with the tax consultants taking a hefty cut off the top.
“This case is about fairness. Businesses that utilize our transit system because their company and their employees are located in our service area should pay their proper share of taxes, and not try to shift that burden on to others,” stated Costello. “These tax consultants and businesses that are misdirecting tax dollars in secret deals should be ashamed, and we are intent on stopping this practice.”
The 2004 legislation gives the RTA and other local governments the right to sue to force repayment of the lost revenues, plus interest, fees and penalties. The FOIA portion of the suit would make the secret agreements public, and require Kankakee and Channahon to identify the companies involved in the scheme and the amount of money being diverted from taxpayers to private business.
“This suit is not an attempt to bankrupt Kankakee and Channahon,” said RTA Chairman John Gates. “It is an attempt by the RTA Board to fulfill its fiduciary responsibility to our riders by collecting every penny that is owed to the transit system. We would prefer not to go to court, but these municipalities, and others engaged in this practice, have made it clear that they will not stop unless we make them.”
The RTA will also be working diligently this year to pass legislation that clarifies the tax code and permanently ends these tax schemes in a manner that preserves the right of municipalities to engage in legitimate economic development activities.