Could an Illinois resident claim an other-state credit after that state recharacterized wages from an S corporation as the shareholder's distributive income?

Plain-English summary

Illinois did not allow the resident credit to include tax attributable to wages that Illinois sourced to itself. The Illinois resident owned more than 20% of an out-of-state S corporation. The other state recharacterized his wages as pass-through distributive income and imposed additional tax, but his W-2 did not report wages to that state and the S corporation treated all employee compensation as Illinois-sourced.

Section 601(b)(3) limited the credit using income that would be sourced outside Illinois if every state applied Illinois Article 3. Because the shareholder lived and worked in Illinois and his base of operations appeared to be Illinois, Section 304(a)(2)(B) sourced all of the compensation to Illinois. None entered Schedule CR column B.

The Department limited its answer to 2012 because 2009–2011 were already the subject of administrative hearings.

What this means for you

Another state's recharacterization does not control the Illinois sourcing fraction. Recompute each item under Illinois rules, preserving the distinction between W-2 compensation and pass-through income.

Common questions

Q: Did the other state's tax automatically create an Illinois credit?
A: No.

Q: Why were the wages excluded from Schedule CR column B?
A: Illinois treated them as compensation paid in Illinois.

Q: Did the GIL resolve all audit years?
A: No. It addressed only 2012.

Citations and references

• 35 ILCS 5/601(b)(3) — resident credit and limitation
• 35 ILCS 5/302(a) — allocation of compensation paid in Illinois
• 35 ILCS 5/304(a)(2)(B) — localization and base-of-operations rules
• 35 ILCS 5/701(a)(1) — withholding from compensation paid in Illinois

Subject

Credits – Foreign Tax

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2014.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2014/it-14-0002.pdf

Original ruling text

IT 14-0002 GIL 02/13/14 CREDITS – FOREIGN TAX
Compensation paid in Illinois under IITA Section 304(a)(2)(B) does not qualify for the credit for taxes
paid to other states.
February 13, 2014

Re:

TAXPAYER
Credit for Taxes Paid to STATE

Dear Xxxx:
This is in response to your letter dated December 2, 2014, in which you request a letter ruling. The
nature of your request and the information you have provided require that we respond with a General
Information Letter, which is designed to provide general information, is not a statement of Department
policy and is not binding on the Department. See 86 Ill. Adm. Code 1200.120(b) and (c), which may
be found on the Department's web site at www. tax.illinois.gov.
In your letter you have stated the following:
We are writing to your office for assistance in resolving a denied credit for taxes paid by
the above taxpayer to the State of STATE. The taxpayer is a resident of Illinois and
owns greater than 20% of an STATE S corporation (CORPORATION). The taxpayer
receives a W-2 from CORPORATION along with a K-1 from the company. The
taxpayer’s wages reported on his W-2 do not reflect STATE wages as he lives and
works in Illinois. CORPORATION files all appropriate Illinois returns.
The taxpayer was audited by the State of STATE for 2009, 2010, and 2011. As a result
of the audit, STATE recharacterized his wages as distributable share of income from the
S corporation. Per STATE Revised Code §5733.40(A)(7), a pass-through entity
member/shareholder that directly or indirectly owns at least 20% of the pass-through
entity must apportion any income from the pass-through entity including wages. Wages
are considered distributive share of income by STATE and must be apportioned.
As a result of the STATE audit, the taxpayer filed amended 2009, 2010, and 2011
Illinois income tax returns to claim a credit for additional taxes paid to STATE on his
Illinois personal return. Those amended returns have been denied by the State of
Illinois and the taxpayer has filed protest for each year. We are including with this letter,
copies of the protest letter for each year.
The taxpayer also filed a timely 2012 Illinois resident return and STATE nonresident
return reflecting the results of the STATE audit. The 2012 Illinois return reflected a
credit for tax paid to another state of $13,371, but the taxpayer received
correspondence from Illinois reducing his credit to $4,822. The difference in credit
relates directly to a denial of credit for wages that have been taxed by STATE under
ORC §5733.40(A)(7).
The taxpayer has responded twice by written correspondence to the Illinois Department
of Revenue regarding the 2012 return (copies included) and the taxpayer also spoke
with Mr. Sam Shetley regarding this matter. Mr. Shetley indicated his supervisor (Ms.
Bonnie Graham) would be reviewing the correspondence and would follow-up. As of

.
the writing of this letter, the taxpayer has not received any follow-up on 2012 and is
becoming quite frustrated with all years at issue.
We contacted the Illinois Department of Revenue, Problem Resolution Division, for
assistance on resolving 2009, 2010, 2011 and 2012. The Problem Resolution Division
suggested we write your office as the issue crosses multiple tax years and relates to
allowing a credit for STATE taxes paid by Illinois resident on wages recharacterized as
distributable income from a pass-through entity. The taxpayer would like to have
someone assigned to all years at issue to resolve this matter as efficiently as possible.
Response
Because your letter provides factual background only with respect to 2012, and because you state
that the years 2009, 2010 and 2011 are the subject of administrative hearings, this letter addresses
only the 2012 tax year.
Section 601(b)(3) of the Illinois Income Tax Act (35 ILCS 5/601) allows Illinois residents to claim a
credit for income taxes paid to other states on income that is taxed by Illinois. That section provides,
in part:
For taxable years ending on or after December 31, 2009, the credit provided under this
paragraph for tax paid to other states shall not exceed that amount which bears the
same ratio to the tax imposed by subsections 201(a) and (b) otherwise due under this
Act as the amount of the taxpayer's base income that would be allocated or apportioned
to other states if all other states had adopted the provisions in Article 3 of this Act bears
to the taxpayer's total base income subject to tax by this State for the taxable year.
The Schedule CR, Credit for Tax Paid to Other States, implements this provision by providing for an
itemization of the taxpayer’s base income in Column A of the schedule and an item-by-item
determination in Column B of the amount of base income that would be allocated or apportioned to
other states, if the other states all used the allocation and apportionment provisions of Article 3 of the
Illinois Income Tax Act. The fraction equal to the sum of the amounts of non-Illinois base income in
Column B divided by total base income, multiplied by the taxpayer’s Illinois income tax liability for the
year, is the maximum amount of credit that can be allowed for taxes paid to other states.
In Article 3 of the Illinois Income Tax Act, Section 302(a) (35 ILCS 5/302) provides:
All items of compensation paid in this State (as determined under Section 304(a)(2)(B))
to an individual who is a nonresident at the time of such payment and all items of
deduction directly allocable thereto, shall be allocated to this State.
Section 304(a)(2)(B) of the Illinois Income Tax Act (35 ILCs 5/304) provides that, for employees other
than professional athletes:
Compensation is paid in this State if:
(i) The individual's service is performed entirely within this State;
(ii) The individual's service is performed both within and without this State, but
the service performed without this State is incidental to the individual's service
performed within this State; or

.
(iii) Some of the service is performed within this State and either the base of
operations, or if there is no base of operations, the place from which the service is
directed or controlled is within this State, or the base of operations or the place from
which the service is directed or controlled is not in any state in which some part of the
service is performed, but the individual's residence is in this State.
From your description, it appears that TAXPAYER’s “base of operations” for his employment is in
Illinois, which would mean that all of his employee compensation is sourced to Illinois even if some of
his services are performed outside the State. In addition, Section 701(a)(1) of the Illinois Income Tax
Act (35 ILCS/701) provides that income tax must be withheld by an employer from “compensation
paid in this State (as determined under Section 304 (a)(2)(B) to an individual,” and CORPORATION
reported on his Form W-2 that all of his employee compensation as Illinois sourced under this
provision.
Because TAXPAYER’s employee compensation from CORPORATION is allocable to Illinois under
Article 3 of the Illinois Income Tax Act, none of that compensation may be included in Column B of
the Schedule CR. The maximum amount of credit allowed to TAXPAYER does not include the
amount of Illinois income tax attributable to any of his compensation.
As stated above, this is a general information letter which does not constitute a statement of policy
that applies, interprets or prescribes the tax laws, and it is not binding on the Department. If you are
not under audit and you wish to obtain a binding Private Letter Ruling regarding your factual situation,
please submit all of the information set out in items 1 through 8 of Section 1200.110(b). If you have
any further questions, you may contact me at (217) 782-7055.
Sincerely,

Paul S. Caselton
Deputy General Counsel – Income Tax