Illinois Senate Bill 2531, signed into law in September 2021, created a pass-through entity tax election (PTE) for partnerships and S corporations. Entities that opt into the PTE will no longer be subject to the Illinois income tax normally levied on the individual shareholder/partner. Instead they will be choosing to have the new PTE levied on the corporation/partnership at the entity level. The net result is that PTE tax is deductible at the corporate/partnership level, avoiding the $10,000 State and Local Tax limitation at the individual level. The Internal Revenue Service Notice 2020-75 issued in November 2020, confirms that the S-corporation or partnership will receive a non-separately stated deduction for the payment of the PTE tax.
Tax paid under the PTE generates a state credit to each partner and shareholder to report on their Illinois income tax returns. The credit is generally 4.95% of the owner’s share of Illinois-sourced distributive income, and so the net result to the state remains, in most cases the same.
This election is made annually, with the filing of the IL1120S or IL-1065 return in accordance with Illinois Department of Revenue rules and is irrevocable for the year the election is made. The PTE applies to ALL owners of the partnership and S corporation, including tax-exempt entities; the corporation/partnership can’t pick and choose owners to which the PTE applies.
In order to get the benefit of the deduction in 2021, cash-basis entities must make a payment of the tax in calendar year 2021.
PTE Deduction Details
For taxpayers that are accruing the deduction of the PTE tax, Notice 2020-75 implies that the PTE deduction would be available only in the year paid, though it does indicate that further regulations from the IRS would be forthcoming. Since these regulations have yet to be issued, accrual basis taxpayers face some uncertainty. As such, accrual taxpayers may want to make a payment of the PTE tax before year end as well, if they want to ensure the deductibility in 2021.
These payments can be made electronically on mytaxillinois.gov, or by mailing the payment with a voucher IL-1065-V (for partnerships) or IL-1120-ST-V (for S-corporations).
If an entity does NOT make a payment in 2021, and instead pays the PTE tax in 2022, it is still deductible in 2022. Depending on what action Congress takes regarding 2022 tax rates, this deduction in 2022 could perhaps even be more valuable than a deduction in 2021.
Although the Illinois rate of the PTE and the Individual income tax remains the same, there are instances where careful evaluation should be done to see if it is beneficial for the entity shareholders. For example: the tax base of the PTE doesn’t allow deductions for the standard exemption, net operating loss carryforward deduction, and the subtraction for owners that are themselves subject to replacement tax or exempt organizations. Further, partnerships aren’t allowed the deduction for reasonable compensation or personal service income. Also, the credits for taxes paid to other states can become convoluted if you have income apportioned to other states or shareholders/partners that are residents of states other than Illinois.
If you have questions as to whether the PTE election is appropriate for you, we would be happy to help you assess your situation and make payments where appropriate. For additional information call us at 630.954.1400 or click here to contact us. We look forward to speaking with you soon.