Executive summary
On June 7, 2023, Illinois Gov. J.B. Pritzker signed Senate Bill 1963, amending the state’s investment partnership provisions. The revised law may provide an easier path to qualify as an investment partnership, although new nonresident withholding obligations may complicate compliance. A summary of the changes is explained below.
New definitions and withholding scheme require due diligence
Revised definitions
Included in Senate Bill 1963 are revisions to the terms “investment partnership” and “qualifying investment securities.” For tax years ending on or after Dec. 31, 2023, the 90% qualification requirements within the investment partnership definition have been expanded. Qualifying investment partnerships must have at least 90% of its gross income consist of interest, dividends, gains from the sale or exchange of qualifying investment securities and new to the requirement, the distributive share of partnership income from lower-tier partnership interests meeting the definition of a qualifying investment security. Unchanged, a qualifying partnership must also have at least 90% of the cost of its total assets consist of qualifying investment securities, deposits at banks or other financial institutions, and office space and equipment reasonably necessary to carry on the activities as an investment partnership. Finally, removed from the qualification criteria is the requirement that the investment partnership not be a dealer in qualifying investment securities.
For tax years ending on or after Dec. 31, 2023, the definition of qualifying investment security now includes a new exclusion and inclusion. Specifically, excluded from the definition of qualifying investment securities are securities with respect to which the taxpayer is required to apply the rules of federal section 475(a). This exclusion coupled with the revised investment partnership definition appears to change the focus to the specific holdings of the investment partnership as opposed to the overall dealer status of the investment partnership itself. The new inclusion to the qualifying investment securities definition is for a partnership interest that, in the hands of the partnership, qualifies as a security within the meaning of subsection (a)(1) of Subchapter 77b of Chapter 2A of Title 15 of the United States Code (federal code definitions related to domestic securities).
New withholding provisions
Also included in Senate Bill 1963 is a new ‘investment partnership’ withholding provision effective for taxable years ending on and after Dec. 31, 2023, requiring investment partnerships to withhold tax from each nonresident partner, other than a tax-exempt partner or an exempt retired partner. The tax is calculated based on the share of income that is distributable to a nonresident partner that, but for the investment partnership exemption, would be apportioned or allocated to Illinois. A notable exemption to the withholding tax base is nonbusiness income this is allocated to the commercial domicile of the taxpayer (interest, dividends and capital gains and losses from the sale of intangibles).
The tax rates for the new withholding tax are the same as they are under the existing nonresident withholding tax regime except that if the partner is a partnership or S corporation, the rate is equal to the rate imposed on individuals, i.e., 4.95%. An additional difference between the new investment partnership withholding tax and the existing nonresident withholding tax regime is that although credits allocated to partners are generally allowed to offset the withholding amount, the new investment partnership withholding does not allow exemptions from withholding nor does it allow the nonresident partners to claim a credit for taxes withheld. Although referred to as withholding, the new investment partnership withholding tax serves as an investment partnership entity level tax. The character and state sourcing of the income for the nonresidents remains the same and generally treated as nonbusiness income even though the new investment partnership tax is calculated based off the income allocated to nonresidents.
Takeaways
The amended Illinois provisions provide opportunities for taxpayers, who previously did not qualify as an investment partnership, to possibly take advantage of the investment partnership status. In addition, the new ‘investment partnership’ withholding requirements may create additional compliance requirements for investment partnerships who have historically had no withholding obligations. Affected taxpayers should work closely with their tax advisors to consider the implications of the new law on their business.
