Illinois Income Tax Withholding By Pass-Through Entities: The New Rules
Effective for tax years ending on or after December 31, 2008, all S corporations,
partnerships, LLCs taxed as partnerships and trusts (referred to as "pass-through
entities") must withhold income tax on the distributive share of Illinois
income on behalf of each nonresident shareholder, partner or beneficiary,
even if the income is not distributed. What does this mean?
Pass-through
Entities: Under the new law,
pass-through entities must make a tax payment to the Illinois Department
of Revenue on behalf of the nonresident shareholder, partner or beneficiary
for each taxable year. These payments will be reflected on the respective
K-1s issued. Payment is due by the original due date of the entity's tax
return (e.g. by March 15 for an S corporation with a calendar year-end).
Note that this withholding (calculated at 3% of the nonresident's share
of Illinois business income) does not have to be deducted from the distributions
actually paid to
the nonresidents.
Non-Resident
Owners:
Illinois nonresident shareholders, partners or beneficiaries will not
be required to file a tax return if the payments made by the pass-through
entity on their behalf adequately cover their Illinois tax liability. Those
filing Illinois tax returns must include any income "passed through"
from the entity. They also receive a credit for pass-through tax payments
made on their behalf.
Exclusions:
The withholding requirement does not apply to nonresident shareholders,
partners and beneficiaries if (1) they are included in a composite return,
(2) they provide documentation regarding taking complete responsibility
for their tax obligations (note that this exemption excludes individuals)
or (3) the pass-through entity is a qualifying investment partnership.
How
Does This Work?: Assume the pass-through entity has $100,000
of business income allocated to Illinois and has a 50% resident and 50%
nonresident owner. For a partnership, $1,500 (3% of $50,000) is remitted
to the state on behalf of the nonresident partner and also allocated as
a draw against their partner account. For an S corporation, $1,500 is remitted
to the state on behalf of the nonresident shareholder. As this is in essence
a distribution and S corporations require equal distributions, then $1,500
must also be distributed to the resident shareholder. For a trust, if there
are no distributions, then no K-1s are issued and the entire amount of income
would be taxable by the trust. If distributions are made, consider "holding
back" the withholding tax amount to avoid making distributions in excess
of income.
Be Safe:
Although not required by law, it is a safer, more conservative approach
to consider withholding the tax amount at the time the distribution is made
to the owner. This prospective thinking will help to avoid a cashflow crunch
caused by making distributions without considering the amount of additional
cash needed to cover income tax withholding payments. Since the information
contained herein is of a general and summary nature, no final conclusion
should be made without further review. For additional information, please
contact us at 847-267-9600
