On Sunday May 30th, the Illinois General Assembly passed Senate Bill 2531 which would provide owners of a partnership or S corporation with a workaround to the federal $10,000 state and local tax deduction cap applicable to individual taxpayers. The legislation now goes to Governor Pritzker who is expected to sign the legislation into law, effective for tax years ending on or before December 31, 2021. This FGMK article provides an overview of the new tax SALT workaround provision and issues to consider when analyzing its application.
Before the 2018 tax year, an individual taxpayer could deduct an unlimited amount of state and local tax (“SALT”) payments for federal income tax purposes. As a result of the Tax Cuts and Jobs Act of 2017, beginning with the 2018 tax year, an individual can deduct no more than $10,000 of such taxes paid.
In response to this cap on the deductibility of SALT, Illinois, along with about a dozen other states, has devised a workaround involving a 4.95 percent entity-level tax that is creditable against the owners’ personal Illinois taxes. Late last year, the IRS opened the door for this type of strategy under Notice 2020-75.
For federal tax purposes, the pass-through entity (“PTE”) deducts the Illinois state tax when calculating its taxable income, thereby reducing each partner’s or shareholder’s share of the taxable income. A PTE is not subject to the SALT deduction cap, so it deducts the Illinois tax in full. It should be noted an individual partner or shareholder does not take into account the state tax that the PTE pays when applying the SALT deduction limitation to which the individual is subject.
For Illinois tax purposes, each partner or shareholder gets a credit for his allocable share of the Illinois taxes paid by the PTE. This credit is a dollar-for-dollar reduction of the individual owner’s personal Illinois income taxes. Because both the PTE and individual tax rate are 4.95 percent; it is a wash. Additional guidance and forms have yet to be issued but the following provides an example of how the election works.
A partnership with two partners elects to pay the Illinois PTE Illinois tax for calendar year 2022. The partnership has $2 million of income, on which it pays $99,000 of Illinois PTE tax.
Each partner’s distributive share of partnership income is $950,500 for federal income tax purposes ($1 million less a SALT deduction of $49,500 of PTE tax.) Assuming the partners are at the 37% federal tax bracket, that’s a $18,315 tax benefit for each partner.
Each partner receives a credit under Illinois tax law of $49,500, and this amount is included in each partner’s Illinois income. Thus, each partner has $1 million of partnership income for Illinois tax purposes, on which they each pay Illinois personal income tax at a rate of 4.95 percent, or $49,500.
But the credit of $49,500 wipes out the tax resulting in no additional Illinois tax due.
The PTE election will be an annual irrevocable election. The election is very fact sensitive and each situation must be analyzed separately. For example, the Illinois PTE election may not be advantageous if the PTE owners are non-residents of Illinois. In such case, most states allow individuals a credit for personal taxes paid to another state to avoid double taxation. With the PTE election, the tax shifts from a personal tax to an entity-level tax. As such, the individual owner taxpayers lose the credit in their home state for taxes paid to Illinois. Additionally, the PTE election may not make sense for an entity with otherwise allowable Illinois income tax credits that flow through to the individual owners. If the credits are non-refundable and the owners have no Illinois tax liability because of the PTE credit, the credits are rendered useless.
For additional information regarding this new legislation, as well as analysis of its application to your entity's and your personal income tax situation, please contact FGMK’s SALT team.
The summary information in this document is being provided for education purposes only. Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.
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