Illinois' Could Be Start of Tax-Hike Wave

NEW YORK ( TheStreet) -- Business owners beware: The massive tax hikes passed Wednesday in Illinois may be implemented in other states as legislators look to quash escalating budget deficits.

Illinois' state legislature sent ripples in the tax community with this week's passage of huge tax increases to personal and corporate income.

As part of the changes, the individual income tax rate for Illinois residents will rise this year by two-thirds, to 5% from 3%, before falling to 3.75% beginning in 2015 and to 3.25% in 2025.

The bill also calls for corporate income tax rates to rise to 7% from 4.8%. That level will fall to 5% in 2015 and back to 4.8% in 2025.

Furthermore, the bill calls for a four-year suspension of the net operating loss deduction, a commonly used tax strategy for business owners. The suspension is expected to cost $250 million annually, small-business advocates say.

The moves are significant, especially to small businesses that are not typically incorporated and instead pay individual income taxes.

"Most business owners are sole proprietors -- S-corps, LLCs -- so when you raise the personal income you're hitting the bottom line of businesses," says Ray Keating, the chief economist at the Small Business and Entrepreneurship Council.

Observers say the new rates will stifle business recovery in the state, limit start-ups and deter investors from Illinois-based businesses. But more importantly, some wonder whether other states will take a page from the Illinois state legislature and also raise taxes.

"I think every state has to look at their financial picture, and most of them are running deficits right now," says Jim Kane, a managing director and co-founder of Chicago-based tax consultant firm True Partners Consulting.

Kane says the move by the Illinois state legislature was risky given the economic environment, in which multiple federal measures have been put together to spur economic growth, particularly for small businesses.

"If they are operating as a corporation then this will probably cause them not to operate as a corporation," he says of entrepeneurs. "If they're looking to start a business and there is a choice, this is a pretty high rate. They may choose another state if they have that flexibility."

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