Illinois enacts income and franchise tax changes

Illinois Gov. J.B. Pritzker recently signed the fiscal 2022 budget bill containing significant provisions addressing Illinois income and franchise taxes. These provisions include a temporary limitation of the net operating loss (NOL) carryover deduction to $100,000 per year, a decoupling from 100% bonus depreciation, changes to align domestic and foreign dividends received deduction rules, and the elimination of the planned phaseout of the Illinois franchise tax.¹ Additionally, on June 25, 2021, S.B. 2531 was passed by the Illinois legislature. Expected to be signed by Gov. Pritzker, this bill creates a pass-through entity (PTE) tax regime to provide a workaround to the federal SALT deduction cap for individuals by allowing a partnership or S corporation to elect to pay an entity-level tax.²

NOL provisions

Under the legislation, C corporations are limited to utilizing $100,000 of NOL carryforwards as a deduction for each taxable year ending on or after Dec. 31, 2021, and prior to Dec. 31, 2024.³ This limitation is similar to the previous limitation for taxable years ending on or after Dec. 31, 2012 and before Dec. 31, 2014.⁴ If a corporation is impacted by the limitation in a given year, that year will not be counted for purposes of the 12-year carryforward period in which previously generated NOLs must be used.⁵

Bonus depreciation decoupling

Illinois has conformed to 100% bonus depreciation since the Tax Cuts and Jobs Act of 2017 (TCJA)⁶ reinstituted the concept for federal income tax purposes.⁷ Under the budget bill, Illinois will no longer conform to 100% bonus depreciation for tax years ending on or after Dec. 31, 2021. Rather, all income taxpayers will be required to calculate depreciation based on the modified accelerated cost recovery system (MACRS), which allows for depreciation deductions on purchased assets over a period of several years depending upon the life of each asset.⁸ The application of MACRS principles will result in an addition to taxable income in the year in which each asset is placed into service, and subtraction modifications for later tax years until each asset is fully depreciated.⁹

Alignment of dividend deductions

Prior to enactment of the budget bill, Illinois conformed to the concept of global intangible low-taxed income (GILTI) as includible in taxable income, but allowed for a 100% deduction as a foreign dividend.¹⁰ Under the budget bill, C corporations are required to add back the 50% GILTI deduction (i.e., the amount that is deductible for federal income tax purposes under IRC Sec. 250(a)(1)(B)(i)) for tax years ending on or after June 30, 2021.¹¹ Likewise, C corporations are required to add back the federal income tax deductions available under IRC Secs. 245A(a) (foreign source portion of dividends received from specified 10% owned foreign corporations) and 243(e) (domestically treated dividends from foreign corporations from earnings and profits accumulated by taxable domestic corporations) for tax years ending on or after June 30, 2021.¹²

Revival of franchise tax regime

S.B. 689, which was enacted in 2019, previously provided for a phaseout and repeal of the Illinois franchise tax by Jan. 1, 2024.¹³ As part of the budget bill, the planned phaseout and repeal have been eliminated.¹⁴ Thus, all taxpayers required to file the Illinois franchise tax will be required to do so going forward, with a $1,000 exemption from tax liability that continues to apply.

Enactment of Illinois elective PTE tax regime

With the likely enactment of S.B. 2531, Illinois will join many other states providing for an optional PTE tax for partnerships and S corporations.¹⁵ For tax years ending on or after Dec. 31, 2021, PTEs may make an annual irrevocable election to be taxed at the entity level and pay tax at the rate of 4.95% of the taxpayer’s net income.¹⁶ The election is only available for tax years in which the federal limitation on individual deductions under IRC Sec. 164(b)(6) applies.¹⁷ The partners or shareholders of an electing PTE are entitled to a pro rata credit for the tax paid by the PTE under the PTE tax regime.¹⁸

Commentary

Earlier this year, Gov. Pritzker identified four alleged “corporate loopholes” in an effort to close the budget gap, claiming that eliminating such loopholes would save the state $655 million.¹⁹ The $655 million amount consists of $314 million from the NOL deduction cap, $214 million from bonus depreciation decoupling, $107 million from the alignment of the domestic and foreign dividends received deductions, and $20 million from the reversal of the phaseout of the Illinois franchise tax.²⁰ While the characterization of such provisions as loopholes may have paved the way for their passage through the Illinois legislature, a suspension of NOL usage and decoupling from 100% bonus depreciation do not provide a permanent tax benefit. Rather, these provisions, which are designed to generate the vast majority of additional tax revenue under the budget bill, consist of timing adjustments that will reverse over time. In addition, many of these provisions immediately apply, which could require evaluation of these changes in the ASC 740 calculation.

The repeal of the arcane franchise tax was welcomed by taxpayers in 2019, the same year Gov. Pritzker proposed a self-described “fair tax” that was contingent upon an amendment to the Illinois Constitution. The constitutional amendment was overwhelmingly rejected by Illinois voters in 2020 and therefore the “fair tax” did not take effect.²¹ Perhaps because the franchise tax and “fair tax” provisions were considered part of an overall tax reform effort, the failure of the “fair tax” at the ballot box necessitated the revival of the franchise tax. Given that the franchise tax does not generate a substantial amount of revenue but instead acts as a trap for unwary taxpayers, Illinois might be better served by considering streamlined adjustments to the franchise tax that would align such tax with franchise tax bases in other states.

Beyond the revenue-generating measures in the budget bill, the PTE tax contained in a standalone bill expected to be signed in the near future provides an opportunity for taxpayers that own an interest in a PTE the ability to circumvent the TCJA’s $10,000 cap on the SALT deduction for individuals. As the ability to elect is available for the 2021 tax year, it will be imperative for the state to quickly provide further guidance on how the PTE can make the election, and for PTEs and their owners to evaluate whether the PTE tax regime should be utilized in Illinois this year.