On Aug. 16, 2013, Illinois enacted H.B. 3157, making major changes to Illinois’ income tax treatment of pass-through entities and their owners. Most notably, effective for tax years ending on or after Dec. 31, 2014, pass-through entities, including partnerships, limited liability companies, S corporations and trusts, will no longer be able to use composite filing of tax returns and will be required to withhold Illinois tax on both business and nonbusiness income.
For tax years ending before Dec. 31, 2014, Illinois law allows a pass-through entity to file a composite return (IL 1023-C) on behalf of its nonresident partners or shareholders. The filing of IL Form 1023-C operates to satisfy each nonresident partner or shareholder’s Illinois filing requirement. H.B. 3157 ends the authority of the Illinois Department of Revenue’s authority to permit the filing of composite returns. Accordingly, for tax years ending on or after Dec. 31, 2014, nonresident owners of interests in pass-through entities will be required to file separately in Illinois.
Regardless of the changes in filing method imposed by H.B. 3157, pass-through entities continue to be required to withhold on behalf of nonresident partners or shareholders. However, while prior law required withholding only on business income distributable to nonresident partners and shareholders, H.B. 3157 provides that additional withholding will be required on nonbusiness income and certain credits.
While withholding was previously reported on IL Form 1000, it appears the state intends to change to a method under which a pass-through entity will pay withholding with its entity return. The Illinois Department of Revenue has yet to issue formal guidance on how withholding payments are to be made on the IL-1120, IL-1065, and IL-1041 returns.
Pass-through entities with nonresident partners and owners should consider the impact of these new rules on future filings and should continue to follow this issue, as more guidance is expected from the state on this topic at a later date.