Illinois Pass – Through Entity Tax SALT Workaround Bill Enacted
On August 27, 2021, Governor Pritzker signed Public Act 102-0658 (the Act) establishing the state’s Pass-through Entity Tax regime. The legislation follows a national trend of similar laws passed in many other states. The Act allows taxpayers owning pass-through business entities to bypass the Federal $10,000 annual limit on state and local tax deductions that has been in place since 2018.
The Federal Tax Cuts and Jobs Act of 2017 (TCJA) imposed a $10,000 cap on the deductibility of state and local taxes paid by individual taxpayers on their individual income tax returns (SALT Cap). Prior to TCJA, there was no such limitation in place. The most commonly deducted state and local taxes are real estate property taxes and state income taxes. The SALT Cap materially impacted taxpayers in major metro counties across the country, where real estate property taxes alone commonly exceed the SALT Cap. Immediately following the passage of the TCJA, several states began proposing workaround legislation, similar in nature to the Illinois Act. In late 2020, the IRS released Notice 2020-75, indicating its intent to permit such workaround legislation.
Illinois Legislation Overview:
The Act allows Partnerships and S-corporations to elect to treat the Illinois individual income tax burden of its owners as an entity-level tax. An electing entity would then deduct the entity-level taxes against its business income, resulting in a corresponding reduction in the pass-through income allocated to its owners for Federal income tax purposes. The owners of an electing entity will also receive an Illinois credit for the entity-level tax paid, resulting on a complete offset of their Illinois individual-level income taxes on the pass-through income, In other word, the owner’s Illinois income tax attributable to their pass-through income is shifted from being an itemized deduction subject to the SALT Cap to a business deduction that reduces their pass-through income from the entity.
Illinois Legislation Details:
- The election is available for tax years ending on or after December 31, 2021 and beginning prior to January 1, 2026 (2021 through 2025 for calendar year taxpayers).
- Generally, Partnerships and S-corporations are eligible for the election. This includes an LLC filing as a Partnership for tax purposes.
- The election is a separate annual election and is irrevocable, once made.
- Electing entities will pay tax at the 4.95% individual income tax rate on the Illinois source income of the entity.
- Owners of an electing entity will receive an Illinois tax credit equal to 4.95% of their distributive share of income.
- Excess credit of an owner can be treated as a refundable overpayment on their individual tax return.
- Electing entities are required to remit estimated tax payments for the entity-level tax.
- Like the rule for non-resident withholding, non-resident owners of an electing entity are not required to file an Illinois tax return, if they have no other Illinois source income and their tax credit equals or exceeds their Illinois tax liability.
- The Act allows Illinois residents to treat substantially similar elective pass-through entity taxes paid to another state as paid by the owner, for purposes of claiming the credit for taxes paid to other states (preventing double taxation.)
Additional guidance is expected to be issued by the Illinois Department of Revenue (DOR) regarding:
- The form and manner of making the election.
- The form and manner for remitting the required estimated taxes, including how 2021 estimate requirements will be imposed.
- IRS Notice 2020-75 states that otherwise qualifying payments are deductible by the entity in the year in which the payment is made. Consideration should be given to the timing of estimates prior to year-end to potentially accelerate deductions, once DOR guidance is available.
- Entities with multi-state income allocations and non-resident owners will need to consider whether the Illinois pass-through entity credit is eligible to be treated as a credit for taxes paid to other states to prevent double taxation in other states.
- Owners of electing entities may need to coordinate and adjust their otherwise planned Illinois individual income tax estimates.
This legislation is taxpayer friendly and creates an opportunity for significant tax savings for many small business owners.