On August 27, 2021, Illinois governor JB Pritzker signed Senate Bill 2531 (SB2531) into law, allowing qualified partnerships and S corporations to elect to pay Illinois income tax at the entity level beginning with tax years ending on or after December 31, 2021, and ending with tax years beginning before January 1, 2026.
Prior to the effective date of SB2531, a partner or shareholder was limited to $10,000 of itemized deductions for state and local taxes (this is called the SALT deduction cap). By paying tax at the entity level, the entity can now deduct the Illinois taxes paid as an expense, reducing its federal taxable income and reducing federal tax expense.
As a result, this circumvents the $10,000 limitation imposed on individuals by expensing the taxes paid at the pass-through entity level. The IRS approved workarounds like this in late 2020 with Notice 2020-75, and several states have since enacted such elections.
Entity-level tax implications
SB2531 will allow for partnerships and S corporations to pay income tax at the entity-level at a rate of 4.95% in Illinois. The election will be required each year and, once approved, will be irrevocable for the tax year the election was made.
For entities making this election, nonresident withholding will no longer be required. However, the pass-through entity will be required to make estimated tax payments if its liability is expected to exceed $500.
Individual tax implications
Illinois residents: For Illinois residents, each partner or shareholder will be able to claim a credit on their individual income tax return equal to their share of the tax paid by the entity to the state of Illinois.
Illinois residents may also be able to take a credit for taxes paid to other states in which the pass-through entity has made an election to be taxed at the entity level. Illinois will allow a credit for taxes paid in states that have enacted “substantially similar” SALT cap workaround laws. The Illinois Department of Revenue will determine whether the tax imposed in other states is substantially similar to the tax imposed in Illinois and is expected to include this guidance in the instructions to the Schedule CR. No credit will be allowed for taxes paid at the entity level in states that are not explicitly approved by the Illinois Department of Revenue.
Illinois non-residents: For non-residents who are partners or shareholders of entities that have made this election, no individual income tax filing will be required in Illinois if the only source of state income for the individual is from an entity making the SALT cap workaround election and if the allowable credit pursuant to the SALT cap workaround equals or exceeds the individual’s liability for the imposed tax for the given tax year.
Other considerations of the Illinois SALT cap workaround
As the election moves the tax to an entity level tax, the partnership or S corporation will be liable for the tax imposed. In the event the entity fails to remit the tax in full, the partners or shareholders will be liable for the tax assessed — including any penalties and interest. Each individual will be liable for their share of the unpaid assessment.
How Wipfli can help
Our tax team delivers comprehensive results for both state and federal taxes fueled by years of experience. Get more information on how we can help, especially with your state and local taxes, on our web page.
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