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."

Wisconsin Gov. Scott Walker issued a statement in direct response to its neighbor's tax hikes, saying the state is "open for business."

"In these challenging economic times while Illinois is raising taxes, we are lowering them," Walker said in a statement. Under Walker's direction, the state legislature is "taking up bills to provide tax relief to small businesses, to create a job-friendly legal environment, to lessen the regulations that stifle growth and to expand tax credits for companies that relocate here and grow here."

But if moving your company is not an option -- small businesses are typically entrenched in the community they serve -- owners will have to take a hard look at their expenses.

Kim Maisch, National Federation of Independent Business' state director for Illinois, says state lawmakers will have "tremendous pressure" to help business owners reduce costs in other areas so as not to raise prices.

"One of the few highlights of Illinois economic policy was that we had a low flat income tax," Maisch says. "We have now thrown out that tool and we've now gone to one of the highest corporate income tax" among all 50 states.

Maisch says business owners don't have many options to offset higher taxes. They can either raise prices on goods and services; trim employee health care benefits, often resulting in employees being forced to pay more; or try to shop around for better workers' compensation programs, for example.

Small-business owners should get politically involved, Keating says.

"Your voice carries more weight in the political process than does the average person because you're a business owner. You matter greatly to the state's economy, so it is critical for you as a business owner to voice your opinion," he says.

--Written by Laurie Kulikowski in New York.

To contact the writer of this article, click here: Laurie Kulikowski.

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