Appeal from the Circuit Court of Du Page County; the Hon.
Robert D. McLaren, Judge, presiding.
JUSTICE REINHARD DELIVERED THE OPINION OF THE COURT:
Plaintiff, National Realty and Investment Company (taxpayer), appeals from that part of the judgment of the trial court confirming the decision of the Department of Revenue (Department) that yearly installments from the 1960 sale of the Drake Hotel by taxpayer were taxable income in Illinois for the tax years 1972 through 1975, 1978 and 1979 under the provisions of the Illinois Income Tax Act (Act). Taxpayer raises two issues on appeal: (1) whether the Act taxes the taxpayer's gain arising from the sale of property nine years before the Act's effective date; and (2) whether denial of the valuation-limitation deduction to corporate taxpayers violates the Illinois and Federal constitutions. The Department has cross-appealed from the remaining portion of the judgment below which reversed the Department's determination that taxpayer's gain on the sale of property in Florida in 1973 was business income and taxable in Illinois, raising the issue of whether the sale resulted in taxable "business income."
A stipulation of facts was agreed to by the parties during the administrative proceeding before the Department's hearing officer. The pertinent facts are as follows. Taxpayer is a Delaware corporation qualified to do business in Illinois with its principal place of business in Oak Brook, Illinois. On December 31, 1960, taxpayer sold the Drake Hotel in Chicago for a total selling price of $10,372,907.77, realizing a gain on the sale of $7,350,813.06. The purchaser assumed a mortgage of $1,712,907.77 with the balance of $8,660,000 to be paid in annual installments of $250,000.
Taxpayer made an election under section 453 of the Internal Revenue Code (26 U.S.C. § 453 (1982)) to report its gain on the sale by the installment method of accounting, reporting as income that portion of each year's payment that the gain on the sale ($7,350,813.06) bore to the total contract price ($8,660,000) or 84.88% of $250,000 which is $212,205.92.
Taxpayer also purchased property in Vero Beach, Florida, on June 30, 1967, for $405,226.59, and sold it on April 11, 1973, for $770,000, realizing a gain of $364,773.41.
In 1972 and 1973, taxpayer deducted $212,205.92 from its taxable income and in 1973 also deducted the gain attributable to the sale of the Florida property. In 1975, the Department mailed taxpayer a timely notice of deficiency assessing additional taxes of $9,230.61 for 1972 and $22,258.22 for 1973. In October 1975, taxpayer filed a protest to the Department's notice of deficiency. Taxpayer again claimed a deduction for the gains realized on the Drake Hotel sale on its 1974, 1975 and 1978 Illinois tax returns. The Department disallowed these deductions treating them as "mathematical errors," and required taxpayer to pay the deficiency immediately. Taxpayer filed a claim for refund due, and subsequently filed a timely protest to the Department's denial of the refund.
In 1979, the purchaser of the Drake Hotel accelerated the payments due taxpayer, paying the remaining balance owed on the contract. On its 1979 amended Illinois income tax return taxpayer deducted $1,666,110.02 of gain realized from the sale of the Drake Hotel and claimed a refund as a result of the claimed deduction of $66,644.40 of the $71,862.37 of the Illinois income taxes paid, plus interest. Taxpayer filed a timely protest to the Department's denial of the claimed refund.
A hearing was held before a Department hearing officer on September 25, 1980, and a decision was issued on December 1, 1980. The Department by its hearing officer found that as income is not "realized" for purposes of the Illinois income tax until reported on the taxpayer's Federal return and included in its computation of Federal taxable income, this tax is not unconstitutionally retroactive. The hearing officer also found that, although the State granted taxpayer a valuation-limitation deduction for the gain reported in 1969 and 1970 pursuant to Thorpe v. Mahin (1969), 43 Ill.2d 36, 250 N.E.2d 633, the legislature amended the Act in 1971, effectively denying a valuation limitation to corporations. The hearing officer found no equal protection violation, noting that the Illinois Supreme Court has upheld differential treatment of corporate and individual taxpayers and found no violation of the "8 to 5" ratio required by article IX, section 3(a), of the Illinois Constitution.
Finally, as to the Vero Beach property, the hearing officer found that taxpayer purchased the lots with the intention of building condominiums on the property. Because of various zoning restrictions, taxpayer could not use the property to build condominiums and neither made improvements on the property nor rented the real estate, it was sold for a gain of $364,773.41 in 1973. Taxpayer paid a tax in Florida in 1973 on only a portion, or $81,876, of the gain. The hearing officer stated that the record, although not "overburdened" with facts on taxpayer's overall business character, shows that taxpayer dealt in real estate, both from the standpoint of management of improved properties and the development of condominiums. He concluded that the ultimate disposal of the property was business income and taxable in Illinois. The hearing officer then assessed deficiencies for the years of 1972 and 1973 and denied refunds for the remaining years in question.
Taxpayer sought judicial review of the Department's decision. The trial court affirmed the decision of the Department as far as the constitutionality of the taxation of the income from the sale of the Drake Hotel. The court found, however, that based on the factual findings of the hearing officer, the income from the sale of the Vero Beach property was nonbusiness income. The court stated that the law requires that not only the acquisition but also the management and disposition of the property be considered in determining whether or not the transaction resulted in business or nonbusiness income. The court also relied on examples contained in the Department's regulations. It should be noted that the examples relied on are not contained in the recently codified Department of Revenue income tax regulations. This appeal and cross-appeal followed.
• 1 Taxpayer first contends that the Act must be construed to apply prospectively only to gains realized after the effective date of the Act, August 1, 1969, a conclusion it argues is supported by the plain language of the Act and the supreme court decisions of Thorpe v. Mahin (1969), 43 Ill.2d 36, 250 N.E.2d 633, and Mitchell v. Mahin (1972), 51 Ill.2d 452, 283 N.E.2d 465. Taxpayer contends that, according to Federal income tax and generally accepted accounting definitions, the entire gain on the sale of the Drake Hotel was realized when the event giving rise to the income occurred, in 1960, and cannot be taxed by the Act which was not effective until 1969. Any other interpretation, it argues, would result in an unconstitutional retroactive tax.
This type of situation, where a sale occurred prior to the effective date of the State income tax but installment payments were received and reported for Federal tax purposes under section 453 after the State tax was in effect, has not previously been addressed by the Illinois courts. (Cf. Warren Realty Co. v. Department of Revenue (1978), 62 Ill. App.3d 450, 379 N.E.2d 100 (tax on the gain from the sale of property acquired 19 years before the effective date of the Act but sold after the Act was in effect was held not to be a retroactive tax).) Courts of other jurisdictions have addressed this issue, however, and have unanimously rejected arguments essentially identical to those presented here. The States deciding the issue had similar income tax statutes which impose an income tax which is a flat percentage of the taxpayer's adjusted Federal income tax liability for the taxable year. Under Illinois' statute, a corporation's base income is equal to the taxpayer's "taxable income" (Ill. Rev. Stat. 1983, ch. 120, par. 2-203(b)(1)), subject to certain adjustments not directly relevant here (Ill. Rev. Stat. 1983, ch. 120, par. 2-203(b)(2)). "Taxable income" is defined by the Act as "taxable income properly reportable for Federal income tax purposes for the taxable year under the provisions of the Internal Revenue Code." (Ill. Rev. Stat. 1983, ch. 120, par. 2-203(e)(1).) The other jurisdictions presented with this issue have held that profits from an installment sale are properly taxable in the years they are received and reported on the taxpayer's Federal income tax under the section 453 installment method, even though the gain would not have been taxable at the time of the actual sale. (Johnson v. Department of Revenue (1982), 387 Mass. 59, 438 N.E.2d 1059; Rosenblatt v. New York State Tax Com. (1981), 85 A.D.2d 770, 445 N.Y.S.2d 289; Roger Dean Enterprises, Inc. v. State Department of Revenue (Fla. 1980), 387 So.2d 358; Dery v. Lindley (1979), 57 Ohio St.2d 5, 385 N.E.2d 291; Fulton v. Lindley (1979), 57 Ohio St.2d 10, 385 N.E.2d 293; Tiedemann v. Johnson (Me. 1974), 316 A.2d 359; Altsuler v. Peters (1973), 190 Neb. 113, 206 N.W.2d 570; Marco Associates, Inc. v. Comptroller of Treasury (1972), 265 Md. 669, 291 A.2d 489; Katzenberg v. Comptroller of Treasury (1971), 263 Md. 189, 282 A.2d 465.) Courts have recognized that the legislative intent in basing State income tax on Federal taxable income was to create a clear, objective criterion for assessing and collecting taxes. (Tiedemann v. Johnson (Me. 1974), 316 A.2d 359, 362.) "This is a formula or yardstick objectively derived which initially takes no account of the source, nature or composition of the funds; it is simply a figure developed by the federal return." Katzenberg v. Comptroller of Treasury (1971), 263 Md. 189, 204-05, 282 A.2d 465, 473.
The cases further determined that the gain was actually realized when payment was received. The Nebraska Supreme Court in Altsuler v. Peters (1973), 190 Neb. 113, 206 N.W.2d 570, stated:
"The taxpayer, in a sense, realizes a gain on an appreciated asset when he sells it, even though he has contracted to take the proceeds over a period of time. Under the provisions of section 453, I.R.C. 1954, if the requirements of that section are met, he may report the gain in installments. The statute and the regulation give him the opportunity of postponing the recognition of a portion of the gain. In effect, he has the option of treating the gain as completely realized at the time of sale, or he may postpone partially the tax consequences until he has actual realization by receiving the installment. It makes little difference whether we say the gain is ...