When the Tax Cuts and Jobs Act was enacted in 2017, the ability of taxpayers to deduct state and local taxes was limited to $10,000. This limitation is commonly referred to as the SALT Cap. For higher income Illinois taxpayers, the SALT Cap increased federal taxes owed.
In 2020, the IRS issued guidance that if pass-through entities (S-Corporations or partnerships, and Limited Liability Companies that have elected to be taxed as either) pay the taxes that would have been owed by the owners, the entity may fully deduct those taxes. In states that allow an entity to pay tax on behalf of its owners, this effectively resurrects the full deductibility of state and local taxes because deducting the tax at the entity level reduces their federal income that flows to them. Illinois has not, until now, permitted a pass-through entity to pay taxes for its members.
With the passage of S.B. 2351, Illinois now permits a pass-through entity to elect to pay a 4.95% tax on its net Illinois-source income. The owner of the entity then receives a credit for the tax paid in proportion to their ownership of the entity which eliminates the Illinois tax due as a result of income from the entity. The Illinois tax may be deducted on the entity’s federal returns, resulting in each owner’s federal taxable income being reduced by their proportionate share of the Illinois tax paid by the entity. Because the tax paid by the entity is equal to what would have been paid by its owners, this measure does not effect state revenues.
If an entity makes the election to pay taxes on behalf of its owners, it must make quarterly estimated payments. The estimated payments supersede withholding requirements for non-resident owners.
If an owner of an entity making the election has no other Illinois source income, the owner is no longer required to file an Illinois tax return. However, the non-resident owner may not be eligible for any credits or deductions their home state provides for taxes paid to other states. Therefore, where an entity has members in multiple states, the impact of making the election on each owner should be carefully considered because the loss of the credit may outweigh the benefit of deducting the Illinois tax.
The Illinois Department of Revenue will be releasing information on the procedure for entities to make the election to pay taxes on behalf of its members. If you are an owner or member of a partnership, LLC or S-Corporation, and wish to discuss whether this new law could benefit you, the attorneys and accountants at Plager, Krug, Bauer, Rudolph & Stodden, Ltd. stand ready to serve you.