On Friday, August 27, 2021, Illinois Governor J.B. Pritzker signed Public Act 102-0658 into law. The Act provides a significant tax break to owners of flow through entities (S corporations and partnerships). According to Crain’s Chicago, a rough estimate of tax savings to affected taxpayers is $80 million annually. The tax break will not affect Illinois tax revenues; it will only affect federal tax revenues.
Why the change?
As you may recall, the Tax Cuts and Jobs Act of 2017 created a $10,000 annual federal limitation on the deduction of state taxes (including income taxes and real estate taxes). The federal limitation created an indirect tax increase on owners of flow through entities who could not fully deduct the state taxes paid on their flow through business income.
Certain states began to look for workarounds to the state tax limitation. For example, what if the state allowed a business to pay the state income tax on behalf of their owners, so that it would become a liability to the business and not the individual? As businesses are not subject to the $10,000 tax limitation, could this create an opportunity to deduct state taxes that would have otherwise been nondeductible to the individual owner? The IRS has recently blessed such workarounds, and Illinois has now enacted the workaround into law.
Here’s how it works
Effective for tax years ending on or after December 31, 2021, and beginning prior to January 1, 2026, Illinois businesses can make an irrevocable annual election to have the business bear the burden of the state tax on the Illinois pass through income. For example, Bob owns an Illinois S corporation that has expected Illinois taxable income of $100,000. Due to high real estate taxes in his home county, Bob gets no benefit from a federal tax deduction of Illinois state taxes paid as his real estate taxes exceed the $10,000 limit. In 2020, Bob paid 4.95% tax on the business income, or $4,950.
Fast forward to 2021. Bob’s S corporation can elect to pay the tax on Bob’s behalf and can claim a federal tax deduction of the $4,950 of tax paid. When Bob files his Illinois income tax return for 2021, he will be allowed a credit of $4,950 on his return. In essence, the Illinois tax stays the same, but Bob has created a federal tax deduction for the state tax paid. Assuming a 37% federal income tax rate, the benefit is a little more than $1,800.
How does this affect you?
We understand that you may have a lot of questions about how the new law will affect you. Cray Kaiser will be looking out for additional guidance on the provisions. In an upcoming blog, we will take a deeper dive into the reasons why a business may not want to pursue this provision.
If you have questions on how the provision will affect you, please give Cray Kaiser a call at (630) 953-4900.