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Q: Why was the new pass-through entity payment law passed?
A:The new law (PA-0233 and PA-0707) was passed for two reasons.
First - to insure compliance with Illinois tax laws. A large number of nonresident partners and shareholders were not filing Illinois tax returns and paying their Illinois tax liability. For the past two years, the Department of Revenue has been manually reviewing partner and shareholder information provided on Illinois income tax returns and contacting partners and shareholders who were not filing returns. This project revealed both widespread ignorance and deliberate disregard of Illinois law. To date, the department has recovered $22.5 million in unpaid tax.
Second – to provide a method for pass-through entities to pay tax on behalf of their nonresident owners that is more flexible and taxpayer-friendly than using composite returns.
Q: In Illinois Dept. of Rev. Info. Bulletin No. FY 2009-02:
an example is provided under the question: When are pass-through payments due? In this example it states that an S Corp using a calendar year would submit its 2008 payment by March 15, 2009. Just to be clear, because this new law applies to tax years ending after 12/31/08, if the entity is on a calendar year, they will not have to make ANY payments until 2010?
A:The new legislation applies to taxable years ending on or after December 31, 2008, so the first payments would be due in 2009. See Section 709.5(a) of the Illinois Income Tax Act (35 ILCS 5/709.5).
Q: [My clients have] both Illinois and non-Illinois individual partners. My partnership clients have invested, some years ago, in other partnerships based in Illinois that are real estate investment partnerships. For the past few years, those underlying investment partnerships have not issued their annual Schedule K-1's until late summer, often not until the beginning of September. All the appropriate returns have been on filing extensions. Since the amount of income attributable to the non-resident partners of my clients is not known by April 15, the deadline for withholding, how are my partnership clients supposed to comply? Incidentally, the amount of income may vary significantly from year to year.
A: The April 15th date was chosen for the due date for [the pass-through entity payment] because that is also the date on which partnerships must pay their own Illinois income tax liabilities. Since they are required to make their best estimate of their own liability for the year by that date, it made sense to have them compute the withholding liability by then, too.
Proposed regulation Section 100.7035(f)(2) provides that a partner will not be subject to penalty or interest as the result of a partnership's failure to timely pay over withholding, unless the partner is personally culpable. The proposed regulation was published in the October 31 Illinois Register, beginning at page 17105.This issue of the Illinois register can be found at: http://ilsos.net/departments/index/register/register_volume32_issue44.pdf
This provision will preclude the imposition of penalties or interest on your clients because of the failure of the real estate investment partnerships to make timely and sufficient payments, and would also preclude the imposition of penalties or interest on the partners of your clients with respect to the tax on their shares of the real estate investment partnerships' incomes, based on the failure of the real estate investment partnerships to make timely and sufficient payments of amounts withheld with respect to your clients.
So, as a practical matter, your clients need to timely report and pay [the pass-through entity payments] only with respect to the income they earn directly and on the amount (if any) timely reported to them by the real estate investment partnerships when they make their [pass-through entity payment].
Q: One issue that is not addressed in the Illinois informational bulletin is the following. While from the Illinois perceptive the non-resident individual may not be required to file an Illinois nonresident 1040, that individual in most cases would be advised to do so anyway. Reason, many other states require a copy of the nonresident state tax return in order to support taking the non-resident state tax credit on their home state. The informational bulletin makes not even the slightest suggestion of this reality and, in fact, would imply the opposite. This is a significant disservice to non-resident taxpayers.
A: Section 502(a) of the Illinois Income Tax Act (35 ILCS 5/502) expressly provides that, if sufficient amounts of pass-through entity payments are made on behalf of a nonresident, no Illinois return is required. What documentation other states require to show entitlement to a credit for taxes paid to Illinois -- or even whether another state actually allows such a credit -- is far beyond the scope of any publication of the State of Illinois.
Q: For the IL-1000, is there going to be an extension form available for this? (As many companies extend and do no file until well after March 15th)
A: No extension is allowed. The Form IL-1000 and the payment are due on the [original] due date [without regard to extension] of the entity's Illinois tax return, which is also the date that payment of the entity's full tax liability is due. No extension is available for paying the entity's tax, and no extension is available for paying the corresponding withholding.
Q: Regarding new Form IL-1000 for payment of pass-through entity payments for non-resident owners, does an extension of the main form IL-1120-ST, IL-1065, or IL-1041 also extend the due date of the IL-1000? This is important because an amended IL-1000 [Form IL-1000-X] is not permitted to claim a refund of overpaid tax, so the owners will all have to claim their own refunds on IL-1040, even if they have no other reason to file. So we preparers will be inclined to underestimate the tax due with the IL-1000 if the main return cannot be completed by the original due date.
If the IL-1000 cannot be extended, it appears that filing a form IL-1023-C (which can be extended) including all non-resident owners would be preferable. However, we are required to petition the Department to include a nonresident who files their own
IL-1040. How in the world are we supposed to know whether the owner will file an
IL-1040? If an owner is included on an IL-1023-C and also files his/her own IL-1040, can he/she claim the credit for tax paid for him/her on the IL-1023-C if we have not petitioned the Department?
A:There is no provision for extending the due date of the Form IL-1000, because it is, in effect, nothing more than the voucher for the payment and the due dates for payment are not extended. Late payments will be subject to penalty and interest.
Regarding the Form IL-1023-C, the Department has proposed amendments to 86 Ill. Adm. Code Section 100.5100(e) that will allow a nonresident to claim on his or her individual return a credit for payment made on his or her behalf on a composite return, without first petitioning the Department.
Q: What is the penalty for not submitting the pass-through [payment]?
A: The penalty for failure by the pass-through entity to never pay the required amount is 10%. Section 713 of the Illinois Income Tax Act (35 ILCS 5/713) provides that this penalty is owed even if you file a return and pay tax on the income with respect to which the pass-through payment was required.
Business/Nonbusiness Income questions
Q: I have a client who is a California resident and a beneficiary of an Illinois trust. The trust passes through only interest and dividends which are taxed by California. IL-1041 instructions say that non-business interest and dividends are not allocable to Illinois.It is therefore my understanding that this new law regarding pass-through entity payments will NOT affect this client.
A: You are correct. Pass-through entity payments are required only from business income apportioned to Illinois, not from nonbusiness income from any source. See Section 709.5(a) of the Illinois Income Tax Act (35 ILCS 5/709.5).
Q: I am trustee of a simple trust for an Illinois Estate. Each year I file an IL-1041 showing the income generated by the trust and how that income is distributed including expenses to the trust and the remainder distribution to the beneficiary in Mississippi. I pay no Illinois taxes and file the return showing zero income to the trust.
The Informational Bulletin describes payments required of "non-resident owners" and "pass-through entities". I have some questions:
1. As I file each year showing no Illinois income, does this new requirement apply to this simple trust?
2. If it does apply, what forms are required to be filed other than the normal IL-1041?
A:The [pass-through entity payment] is required from the business income (if any) of the trust that is apportioned to Illinois and distributed or deemed distributed to the beneficiary. You should have been determining the amount of business income distributed or distributable to the beneficiary each year, and how much is apportioned to Illinois, in filling out the Schedule K-1-T for the beneficiary for each year.
The [pass-through entity payment] is paid with and reported on Form IL-1000.
Q:If a partnership located in Illinois only owns and operates a rental real estate building in Illinois (and that is the entirety of its operations everywhere), is that considered “Illinois business income” that requires [pass-through entity payments to be made for] nonresident partners, or is rental real estate income considered “nonbusiness income” that doesn’t require [pass-through entity payments]? The Illinois Schedule NB seems to indicate that rents from real property in Illinois are nonbusiness income allocable to Illinois, unless you elect to treat all income as business income. If no election is made, is the rental income therefore nonbusiness and NOT subject to [pass-through entity payment] requirements?
A: Section 1501(a)(1) of the Illinois Income Tax Act (35 ILCS 5/1501) defines "business income" to mean "all income that may be treated as apportionable business income under the Constitution of the United States." 86 Ill. Adm. Code Section 100.3010(a)(3)(C) provides that all income is business income "unless clearly classifiable as nonbusiness income." Income from operating rental real estate is likely business income, requiring [pass-through entity payments]. In addition, Section 1501(a)(1) allows taxpayers to elect to treat all of their income (other than employee compensation) as business income. If a partnership makes this election, the Illinois portion of the income distributable to its nonresident partners will be subject to [pass-through entity payments]. Operating rental real estate is likely business income, requiring [pass-through entity payments.]
Q: When a rental property is eventually sold, generating an IRC Sec. 1231 gain, is that gain subject to the new [pass-through entity payment] requirements?
A: If the rental income is business income, the gain on sale of the property will be business income.
Q: In general (excepting banks/financial institutions), [are pass-through entity payments] ever required for nonresident partners’ share of interest/dividend income generated on bank accounts held by the partnership, or is that considered non business income?
A: If the bank accounts are maintained in connection with the partnership's business, the interest will be business income.
Q: If Partnership A is a tiered partnership, that only owns interests in other partnerships, and those other partnerships each are involved only in rental real estate operations (both in and out of Illinois), so that the entire activity of Partnership A is to report flow-thru investments in other rental partnerships, is Partnership A’s share of rental real estate income considered “business” (apportionable) or “nonbusiness” (allocable)? If [considered] nonbusiness, is Partnership A subject to the new [pass-through entity payment] requirements on its nonresident partners?
A: Unless Partnership A itself elects to treat all of its income as business income under Section 1501(a)(1), the determination of whether the income flowing through to it from the partnerships in which it has invested is made by those partnerships. If they determine that the income is business income, they are required to [make pass-through entity payments] based on the share of the Illinois portion of that income distributable to Partnership A (unless Partnership A provides them with a certificate of exemption) and Partnership A will be required to make [pass-through entity payments] from its nonresident partners on their shares of that income (regardless of whether or not Partnership A has provided its partnerships with a certificate of exemption). If Partnership A has elected to treat all of its income as business income, the income will be subject to [pass-through entity payments].
Q:
…what income of a trust [do] you feel will be required to have this "withholding" [pass-through entity payments]? In other words, what do you consider to be Illinois "business" income for a trust? The instructions to IL-1041 say one thing regarding "business" income but this is the same definition they use for corporate entities and partnerships.
We feel that income reflected on a partnership K-1 or S corp K-1 as Illinois source income would be business income subject to [pass-through entity payments]. But what about income from Illinois source 1) rental property, 2) royalty income, 3) copyrights, 4) capital gain from the sale of real property located in Illinois, 5) capital gain from the sale of personal property located in Illinois and 6) capital gain from the sale of intangible personal property located in Illinois? Would income form these sources be subject to the new entity pass through payments?
A:
Section 709.5 of the Illinois Income Tax Act (35 ILCS 5/709.5) requires a trust to withhold tax on a nonresident beneficiary's share of the business income of the trust that is apportioned to Illinois by the trust. For a complete definition of business income, see 86 Ill. Adm. Code Section 100.3010, which can be found at:
http://www.ilga.gov/commission/jcar/admincode/086/086001000I30100R.html
This regulation is accurately summarized in the instructions for the Schedule K-1-T, found at:
http://www.iltax.com/taxforms/Incm2007/Business/Fiduciary/K-1-T.pdf
If you read these sources, you will see that your inquiry does not provide sufficient information for us to answer your questions about specific sources of income.
…the classification of income as business or nonbusiness and the apportionment of business income are not new issues for trusts. If a trust has nonresident beneficiaries, it should have been providing them with Schedules K-1-T, and informing them of the amounts of business income distributed or deemed distributed to them for each taxable year, and of the percentage of that business income that is apportioned to Illinois. This is the income on which withholding is required. So the simplest guidance I can give in response to your questions is: Continue to characterize the income and apportion it in the same manner as you have in prior years.
If you have concerns that a trust has not been properly reporting income in prior years, [the department] would be happy to review what it has been doing, and assist it and its beneficiaries in computing their correct Illinois income tax liabilities so that any deficiencies or refunds may be promptly paid.
Q: If you are a non-resident beneficiary of a trust that only has investment income, this is traditionally sourced to your home state. [Are pass-through entity payments] required?
A:[Pass-through entity payments are] required only from business income, and the statutory and regulatory principles for distinguishing nonbusiness from business income were not changed by the new [pass-through entity payment] statute. If a trust properly treated its investment income as nonbusiness in prior years, it will still be nonbusiness income for 2008 and will not be subject to [pass-through entity payments].
Is there any legislative history on this?
A: The statute is better read to allow the exemption only for non-individuals, and that was the stated intent of the persons who proposed the amendment to the pass-through payment statute in Public Act 95-707, which added the exemption. This reading is incorporated into the instructions for the forms and in proposed regulation Section 100.7035(g)(1)(C), which was published at 32 Ill. Reg. 17105 (October 31, 2008).
Q: …It appears there is no clear inclusion of estates within the requirement to withhold and report on Form IL-1000, Pass-through Entity Payment Income Tax Return. However, estates may be owners of pass-through entities, and eligible to opt out of the requirement by signing Form IL-1000-E. Estates filing Form IL-1000-E certify they will file all Illinois income tax returns, make timely payment of all Illinois income taxes due, and remain subject to Illinois for the purposes of collection of income taxes due with respect to the partnership, corporation or trust identified on Form IL-1000-E; however, estates are not required to file Form IL-1000 but must file form IL-1041.
Please verify whether this interpretation is correct and provide any clarification regarding the responsibility of estates related to the new pass-through entity payment requirement.
A: You are correct. Section 709.5(a) of the Illinois Income Tax Act (35 ILCS 5/709.5) requires [pass-through entity payments] by partnerships, Subchapter S corporations and trusts. Estates are not required to [make pass-through entity payments] under this provision. Section 709.5(c) allows persons other than individuals to exempt themselves from [pass-through entity payments] by providing a certificate to their partnership, subchapter S corporation, or trust. Estates can avail themselves of this provision.
Section 709.5(a) of the Illinois Income Tax Act (35 ILCS 5/709.5) requires [pass-through entity payments] by partnerships, Subchapter S corporations and trusts. Estates are not required to [make pass-through entity payments] under this provision.
Q: Step 2 of the captioned form asks for the FEIN of the exempt owner. If the exempt owner is an individual partner, should not this ask for his or her social security number?
A: Individuals are not allowed to use the Form IL-1000-E to claim exemption from pass-through entity payments. See Section 709.5(c) of the Illinois Income Tax Act (35 ILCS 5/709.5).
Q: Are those amounts that the pass through entity pays a deduction as a state tax expense? It would seem that it is unfair to the resident partners that a payment is being made by the partnership for a tax on behalf of someone just because they are not located in Illinois. In other words, the partnership is paying the state tax for partner A, who doesn’t live here, but not for partner B, who does.
A: As a payment of Illinois tax made on behalf of the partner, which the partner can claim as a refundable credit against his or her Illinois income tax liability, the pass-through entity payment is a distribution to the partner. As such, it is not a deductible expense of the partnership.
Q: For the new requirements relating to [pass-through entity payments] by S corporations on nonresident shareholders: wouldn’t [pass-through entity payments] on nonresident partners cause a disproportionate distribution of income, causing the s corporation to lose its subchapter election?
A: This is a federal income tax question to which [we] cannot respond.
Q: Where do I go to find the IL-1041 for 2008 tax year?
A: The 2008 Forms IL-1041 should be available within a month.
*Update: The IL-1000, and IL-1000-E are currently available. The remainder of the 2008 tax forms will not be available until late December 2008 or early January 2009. If you are a registered on our tax-practitioner list, you may have access to our draft forms web page and the 2008 drafts may be viewed there.
Q: If you are a non-resident and have withholding done on your behalf but have a reportable transaction, you could still have a filing obligation and a large penalty if you do not file?
A: A nonresident who has a reportable transaction would still be required to file a return if necessary to file the required disclosure. 86 Ill. Adm. Code Section 100.5060(c)(4) provides that the disclosure may be filed on behalf of a partner or S corporation shareholder on a composite return, but there is no similar provision that would allow a pass-through entity to file disclosure on behalf of owners for whom it is making pass-through withholding payments.
Q: What happens if the flow-thru entity does not have cash but has distributable income? This could happen in situations where you use debt to create basis. Does a partnership have to do a capital call?
A: There is no exception from [pass-through entity payments] for pass-through entities with insufficient cash. Whether they will address the problem by borrowing or by a capital call or any other means is not something the department can address.