Over Memorial Day weekend, the Illinois General Assembly concluded its spring legislative session by passing a flurry of bills that have been sent to the desk of Gov. J.B. Pritzker for signature. Several of them, including Senate Bill 2017 (2022 Budget Bill) and Senate Bill 2531 (Pass-Through Entity Level Tax Bill), make important tax changes that significantly affect Illinois businesses and their owners. A summary of the most impactful tax-related provisions from the 2022 Budget Bill and the Pass-Through Entity Level Tax Bill is set forth below.
The 2022 Budget Bill
The Illinois legislature approved a $42.2 billion budget for the 2022 fiscal year that draws on, among other things, an estimated $650 million in additional annual revenue from the elimination of several existing provisions of the Illinois tax code that Gov. J.B. Pritzker has characterized as “corporate loopholes.” Although the Governor had initially proposed a litany of tax-related changes (see our prior Sidley Update here), due to an unanticipated increase in current revenues, approximately $8 billion in federal aid from the American Rescue Plan Act of 2021, and pushback from various businesses and interest groups against certain of the Governor’s proposals, the 2022 Budget Bill ultimately included only a subset of his proposed revenue-raising tax changes. Among the most notable tax-related changes are the following:
- Reversal of franchise tax phaseout. The 2022 Budget Bill eliminates the planned phaseout of the Illinois corporate franchise tax, which the Governor had previously agreed to as part of 2019 budget agreement. Under prior law, the franchise tax was set to completely phase out by 2024.
- Temporary cap on corporate NOLs. Under the 2022 Budget Bill, a corporation’s use of net operating losses (NOLs) is limited to $100,000 per year for any taxable year ending on or after December 31, 2021, and prior to December 31, 2024. This provision effectively restores the previous $100,000 limitation that was in place for the 2013 and 2014 tax years. Any taxable years in which an NOL carryforward cannot be used due to the $100,000 limitation does not count against the 12-year NOL carryforward period.
- Decoupling from TCJA bonus depreciation. The 2022 Budget Bill decouples Illinois from federal 100% bonus deprecation provided in the Tax Cuts and Job Act of 2017 (TCJA) and aligns the state with the Modified Accelerated Cost Recovery System depreciation rules under Section 168 of the Internal Revenue Code.
- Decoupling from TCJA 100% foreign-source dividend deduction and 50% deduction for GILTI. The 2022 Budget Bill decouples from the federal deductions for foreign-source dividends and global intangible low-taxed income (GILTI). Instead, corporate taxpayers will be permitted to take advantage of the deductions authorized under Section 243 of the Internal Revenue Code for domestic dividends.
The Pass-Through Entity Level Tax Bill
The TCJA imposed a $10,000 limitation on the deductibility of state and local tax payments made by or on behalf of individuals unless such taxes were paid in connection with a trade or business of the individual (state and local tax, or SALT, Limitation). This significantly limited the itemized deductions of many individual taxpayers, including owners of pass-through entities (such as partnerships and S corporations) that generally incur federal and state income tax at the individual owner level.
The SALT Limitation does not generally apply, however, to taxes paid by an entity. In IRS Notice 2020-75 (Notice 2020-75), the IRS confirmed that pass-through entities will be permitted to fully deduct certain entity-level state income taxes that would otherwise have been paid by the pass-through entities’ owners (effectively resulting in full deductibility at the individual owner level). As such, a growing number of states are creating mechanisms whereby taxes that would otherwise be paid at the individual level may be paid at the pass-through entity level and credited at the individual level in accordance with Notice 2020-75, in order to allow full deductibility of such state taxes. By passing the Pass-Through Entity Level Tax Bill, Illinois has created such a mechanism.
Under the Pass-Through Entity Level Tax Bill, for taxable years ending on or after December 31, 2021, and beginning prior to January 1, 2026 (corresponding to the applicable years under the TCJA for which the SALT Limitation is currently in effect), a partnership or S corporation may annually elect to pay tax on its Illinois sourced net income at the 4.95% rate applicable to individuals. Each individual owner of an electing entity would then be entitled to a credit against the tax imposed, equal to 4.95% times the owner’s distributive share of net income from the entity. There are special rules intended to coordinate payment of the tax and receipt of the corresponding credit in tiered partnership situations. In addition, the bill allows for a credit for taxes paid to other states that have enacted substantially similar optional pass-through entity level taxes. Finally, while an electing entity is absolved from existing pass-through entity withholding requirements on Illinois source income, it is required to make estimated payments throughout the year if the entity’s tax liability can reasonably be expected to exceed $500.
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