Illinois limits NOLs, imposes sales tax on leases

On June 7, 2024, Illinois Gov. J.B. Pritzker signed legislation, H.B. 4951, which amends numerous tax law provisions.¹ The legislation includes corporate income tax changes that extend and change the amount of the annual limitation on the net operating loss (NOL) deduction and amend the apportionment provisions applicable to investment income received by financial organizations. Also, the franchise tax exemption is increased. The legislation amends sales and use tax statutes by subjecting leases of tangible personal property to tax, limiting the vendor’s discount, prohibiting certain interchange fees on taxes and gratuities, and subjecting online travel companies to the hotel operators’ tax. In addition, the legislation adds and amends various income tax credits. Furthermore, the legislature has passed legislation, H.B. 3144, expected to be signed by Governor Pritzker, which would eliminate the 1% state sales tax on groceries but allow local governments to impose a similar tax.²

Corporate income tax 

NOL deduction limitation

The legislation imposes an NOL deduction limitation for three years. For taxable years ending on or after Dec. 31, 2024, and prior to Dec. 31, 2027, the maximum amount of an NOL that a C corporation may deduct is limited to $500,000.³ Prior to amendment, the limitation was $100,000 for taxable years ending on or after Dec. 31, 2021, and prior to Dec. 31, 2024.

Apportionment for financial organizations

For taxable years ending on or after Dec. 31, 2024, the sourcing of a financial organization’s investment income (including interest, dividends, net gains and other income derived from investment activity) to Illinois is based on the sourcing of the other types of income that the financial organization sources to the state, rather than according to the location of its fixed place of business.⁴ As amended, investment income is apportioned to Illinois using a ratio of total Illinois-sourced non-investment income (the numerator) to all receipts except for income from investments (the denominator). Previously, investment income was apportioned to Illinois using a ratio of gross income from investment assets and activities properly assigned to a fixed place of business in Illinois with which the asset or activity had a preponderance of substantive contacts (the numerator) to the gross income from all such assets and activities (the denominator).⁵

Franchise tax

On and after Jan. 1, 2025, the first $10,000 in liability is exempt from franchise tax for both domestic and foreign corporations.⁶ Previously, for domestic corporations, the first $5,000 in liability was exempt from franchise tax beginning in 2024.⁷ For foreign corporations, only the first $1,000 in liability was exempt, but the recent legislation exempts the first $5,000 in liability in 2024 and the first $10,000 in liability after 2024.⁸

Sales and use tax

Taxation of leases

Illinois is imposing sales and use tax⁹ on leases in effect, entered into, or renewed on or after Jan. 1, 2025.¹⁰ Specifically, tax is imposed on the sale or use in Illinois of tangible personal property (other than motor vehicles, watercraft, aircraft, and semi-trailers required to be registered with the state) leased at retail from a retailer or transferred by lease, as an incident of a sale or purchase of a service.¹¹ “Lease” means a “transfer of the possession or control of, the right to possess or control, or a license to use, but not title to, tangible personal property for a fixed or indeterminate term for consideration, regardless of the name by which the transaction is called.”¹² However, the definition of “lease” excludes any “lease entered into merely as a security agreement that does not involve a transfer of possession or control from the lessor to the lessee.”¹³ Because the definitions of “sale at retail” and “use” are expanded to include leases, the existing exemptions from the tax apply to lease transactions.¹⁴

The lessor, in collecting the tax, may collect for each tax return period, only the tax applicable to the part of the selling price actually received during the tax return period.¹⁵ An exemption is provided for use by the lessee of the following types of leased tangible personal property: (i) software transferred subject to a restrictive license that meets numerous requirements;¹⁶ and (ii) property subject to a tax on lease receipts imposed by a home rule unit of local government if adopted prior to Jan. 1, 2023.¹⁷

The law adds new sourcing provisions for lease transactions.¹⁸ For a lease that requires recurring periodic payments and for which the property is delivered to the lessee by the lessor, each periodic payment is sourced to the primary property location for each period covered by the payment.¹⁹ For all other leases, including a lease that does not require recurring periodic payments and any lease for which the lessee takes possession of the property at the lessor’s place of business, the payment is sourced using the provisions for sales at retail other than leases. Also, the sale for resale provisions are amended to address lease transactions.²⁰ On and after Jan. 1, 2025, a sale to a lessor of tangible personal property who is subject to tax on the leases, for the purpose of leasing that property, is made tax-free as a sale for resale, provided the other sale for resale provisions are met.

Vendor’s discount and interchange fee

Beginning with returns due on or after Jan. 1, 2025, the 1.75% discount that vendors may retain for most types of sales transactions is limited to $1,000 per month for purposes of the sales and use tax, including any local tax administered by the Department and reported on the same return.²¹

Effective July 1, 2025, the legislation enacts new provisions prohibiting credit card interchange fees on sales and use taxes, excise taxes, and gratuities.²² As defined by the new statute, “interchange fee” means a “fee established, charged, or received by a payment card network for the purpose of compensating the issuer for its involvement in an electronic payment transaction.”²³ The new statute provides that an issuer, a payment card network, an acquirer bank, or a processor may not receive or charge a merchant any interchange fee on the tax amount or gratuity of an electronic payment transaction if the merchant informs the acquirer bank of the tax or gratuity amount as part of the authorization or settlement process for the transaction.²⁴ The merchant must transmit the tax or gratuity amount data as part of the authorization or settlement process to avoid being charged interchange fees on the tax or gratuity amount of an electronic payment transaction.

Hotel operators

Beginning July 1, 2024, an online travel company, termed a “re-renter of hotel rooms” in the statute,²⁵ is considered a hotel operator responsible for collecting the Hotel Operators’ Occupation Tax.²⁶ If the re-renter is headquartered outside Illinois and has no presence in the state other than its business as a re-renter, conducted remotely, the re-renter is considered the hotel operator if it meets one of the following thresholds: (i) the cumulative gross receipts from rentals in Illinois by the re-renter of hotel rooms are at least $100,000; or (ii) the re-renter of hotel rooms cumulatively enters into 200 or more separate transactions for rentals in Illinois.²⁷ A new statute provides that a hotel operator who rents, leases, or lets rooms to a re-renter of hotel rooms incurs the tax on the gross rental receipts it receives from that re-renter of hotel rooms and cannot claim any resale exception.²⁸ In this situation, the re-renter incurs the tax on its gross rental receipts, but may take a credit for the amount of tax it paid to a hotel operator as reimbursement for the tax incurred for the rental of the room for the purposes of re-rental.²⁹

Sales tax on groceries

The legislature has passed a bill, H.B. 3144, which is expected to be approved by Governor Pritzker and would eliminate the state’s 1% sales and use tax on groceries.³⁰ Beginning Jan. 1, 2026, food for human consumption that is to be consumed off the premises where it is sold (other than alcoholic beverages, food consisting of or infused with adult use cannabis, soft drinks, candy, and food that has been prepared for immediate consumption) would be exempt from the 1% sales tax imposed by the state.³¹ However, new provisions included in the legislation would allow counties and non-home rule municipalities to impose a 1% tax on groceries that takes effect on or after Jan. 1, 2026.³²

Income tax credits

The legislation enacts the following new income tax credits: (i) child tax credit;³³ (ii) Illinois Gives tax credit that may be taken for making an endowment gift to a permanent endowment fund;³⁴ (iii) local journalism sustainability;³⁵ and (iv) music and musicians tax credit.³⁶ Also, the legislation amends, expands, or extends the following tax credits: (i) live theater production;³⁷ (ii) voluntary emergency workers;³⁸ (iii) credit for wages paid to returning citizens (previously, credit for wages paid to ex-felons);³⁹ and (iv) student-assistance contributions.⁴⁰

Commentary  

This is the most significant tax legislation that Illinois has enacted in several years and is generally intended to increase state tax revenue. An amendment to the corporate income tax extends the limitation of the NOL deduction for C corporations by three additional years, but is tempered somewhat by increasing the annual limitation from $100,000 to $500,000. Although the legislature originally planned to make this limitation permanent, the legislature eventually decided to only impose the limitation for three more years. Of course, this limitation could be extended in the future, and it follows the trend of several large-market states that have imposed significant restrictions on utilization of their state NOL attributes.

The sourcing provisions for investment income received by financial organizations is now based on the sourcing of other income streams rather than a fixed place of business. In addition to somewhat simplifying the sourcing calculation, this new sourcing method should be favorable to Illinois-based financial organizations by lowering the income that is sourced to the state, though it could negatively affect financial organizations based outside the state.

Although the income tax changes are noteworthy, the most significant provisions in this legislation concern sales and use tax. Prior to this legislation, Illinois differed from nearly every other state by taxing the sale of tangible personal property that was leased rather than taxing the lease payments. This legislation amends Illinois law to tax leases in a manner more consistent with other states. The taxation of lease transactions begins on Jan. 1, 2025, but taxpayers should note that lease transactions started in prior years are subject to the new provisions if the lease is in effect on that date. For purposes of the relatively narrow exemption for leases of software, the legislation codifies the five requirements needed to exempt a license of software from sales tax that are provided by an existing regulation.[1] An exemption also is provided for leases subject to the Chicago Personal Property Lease Transaction Tax. Lessors should update their systems to reflect the new provisions for taxing lease transactions.

The $1,000 monthly cap on the vendor’s discount will adversely affect large retailers, though this change could be partially mitigated by the provision prohibiting the imposition of interchange fees on sales and use taxes, excise taxes, and gratuities. Also, hotel operators and online travel companies should consider the changes to the hotel operators’ tax for “re-renters of hotel rooms” that are effective July 1, 2024. This may necessitate immediate changes to their hotel operators’ tax software systems.