How should the royalty income earned by nonresident members of a musical band (organized as a partnership) be sourced to Illinois for income tax purposes?

Plain-English summary

An out-of-state tax preparer wrote to the Illinois Department of Revenue about a new client: a general partnership made up of three individual musical artists who together form a band. The band earns income from four sources — recording royalties, publishing royalties, touring, and merchandising. Some of the band's albums were written and recorded in Illinois years ago, but the band is no longer active in Illinois. One band member lives in Illinois; the other two do not. The preparer asked how much of the royalty income earned by the nonresident band members should be sourced (i.e., taxed) to Illinois.

Because the request didn't lay out enough specific facts for a binding Private Letter Ruling, the Department responded with a General Information Letter (GIL) instead, explaining the general framework rather than resolving the specific numbers.

The Department explained that a nonresident partner's share of partnership income is either "allocated" (for nonbusiness income) or "apportioned" (for business income) to Illinois under Section 305 of the Illinois Income Tax Act (IITA). Based on the facts described, the Department said the band's royalty income appears to be business income, which means it gets apportioned to Illinois using the partnership's sales factor under IITA Section 304 — including special sourcing rules for royalties from patents, copyrights, and trademarks. Each nonresident partner then must include their distributive share of that Illinois-apportioned business income in their own Illinois net income. The partnership also has a duty to withhold Illinois tax on that apportioned amount under IITA Section 709.5.

What this means for you

If you are a nonresident partner earning royalties connected to Illinois

Under IITA Section 305, a nonresident partner doesn't automatically owe Illinois tax on all partnership income — only on the portion allocated or apportioned to Illinois. If the income is "business income," it's apportioned using the partnership's sales factor under Section 304, which for royalties from copyrights, trademarks, and similar intangible property looks at where those items are "utilized" (for example, where a copyright is printed/published, or where a licensee's commercial domicile is located).

If you are the partnership (or its tax preparer)

The partnership itself may owe Illinois's separate entity-level Personal Property Replacement Tax on its net income (35 ILCS 5/201(c) and (d); 5/202), and it must withhold Illinois tax on each nonresident partner's Illinois-apportioned distributive share under IITA Section 709.5. Whether royalty income counts as "business income" (apportioned) versus "nonbusiness income" (allocated) drives which sourcing rule applies, so that classification matters a great deal for both the partnership's withholding obligations and each partner's individual filing.

Remember this is a GIL, not a binding ruling

The Department stressed that this letter is a General Information Letter under 2 Ill. Adm. Code § 1200.120(b) and (c) — it gives general guidance based on the facts as described, but it is not a statement of Department policy and is not binding on the Department. Taxpayers with the same kind of question should not assume this letter guarantees a specific outcome for their own facts.

Common questions

Does a nonresident partner pay Illinois tax on all of a partnership's income?
No. Under IITA Section 305, a nonresident partner only picks up the portion of the partnership's income that is allocated or apportioned to Illinois — not the entire distributive share.

How is royalty income from a copyright or trademark sourced to Illinois?
Under IITA Section 304(a)(3)(B-1), a copyright is generally "utilized" where printing or publication originates, and trademarks are generally utilized where the licensee's or purchaser's commercial domicile is located; gross receipts tied to that Illinois utilization go into the numerator of the sales factor.

Does the fact that the band recorded albums in Illinois years ago, but is no longer active there, matter?
The ruling doesn't isolate that fact as separately controlling; instead it directs the preparer to apply the general business-income apportionment rules of IITA Section 304 (and the intangible-property sourcing rules within it) to determine what, if any, current royalty receipts are tied to Illinois utilization.

Does the partnership have any withholding duty for its nonresident partners?
Yes. IITA Section 709.5 requires the partnership to withhold Illinois tax on each nonresident partner's share of business income apportioned to Illinois (and, for tax years ending on or after December 31, 2014, certain nonbusiness income allocated to Illinois), net of certain credits.

Citations and references

• 35 ILCS 5/305 — Allocation of Partnership Income by partnerships and partners other than residents
• 35 ILCS 5/1501(a)(1) — Definition of "business income"
• 35 ILCS 5/1501(a)(13) — Definition of "nonbusiness income"
• 35 ILCS 5/301(c)(2) and 35 ILCS 5/303 — Allocation of nonbusiness income
• 35 ILCS 5/304(a) — Apportionment formula (sales factor) for business income
• 35 ILCS 5/304(a)(3)(A) — Definition of the sales factor
• 35 ILCS 5/304(a)(3)(B-1) and (B-2) — Sourcing rules for royalties from patents, copyrights, trademarks, and similar intangible property
• 35 ILCS 5/709.5 — Partnership withholding obligation for nonresident partners, shareholders, and beneficiaries
• 35 ILCS 5/201(c) and (d); 35 ILCS 5/202 — Illinois entity-level tax on partnership net income
• 2 Ill. Adm. Code § 1200.120(b) and (c) — General Information Letter policy (non-binding, general guidance only)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2016.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2016/it-16-0002-gil.pdf

Original ruling text

IT 16-0002-GIL 2/9/2016

APPORTIONMENT

Non-resident partner includes in Illinois net income his or her distributive share of the business
income of the partnership apportioned to Illinois.

February 9, 2016

Re:

Illinois income tax

Dear Xxxxx:
This is in response to your letter dated December 29, 2015 in which you request a letter ruling. The
nature of your request and the information provided requires that we respond with a General
Information Letter (GIL). A GIL is designed to provide general information, is not a statement of
Department policy and is not binding on the Department. See 2 Ill. Adm. Code § 1200.120(b) and (c),
which may be accessed from the Department’s web site at www.tax.illinois.gov.
Your letter states as follows:
I am an out of state tax preparer who recently took over a new client. The client is a general
partnership made up of three individual musical artists that combined make up a musical band.
These artists have four primary sources of income.
Recording – They make records, which are either owned or licensed by a record company in
which the record company pays them a royalty for records sold.
Publishing – They are paid royalties for music sold or played via the airways or streamed.
Touring – They perform via musical touring.
Merchandising – They license their name to merchandisers who sell product with the band’s
name on it (i.e. hats, shirts, etc.)
The band has not recorded an album in several years. However, when they did record, a few
of their albums were written and recorded in Illinois. Currently they are no longer active with
respect to business in Illinois. One band member is a resident of Illinois, while two of the band
members are not residents of Illinois.
The question we have is with respect to the royalties they earn and their sourcing (if any) to the
State of Illinois. The record company pays a royalty primarily with respect to three parts:

1. For their actual services for performance on the recording (done many years ago in Illinois).
2. For the writer’s share (for writing the songs many years ago in Illinois).
3. For the publisher’s share (licensing the rights to the songs).
   The record company does not manufacture or distribute recordings out of Illinois. CDs are sold
   to customers around the world, including a small portion of that (we presume) to persons
   located in Illinois. In addition, music is played all around the world (either through the airways
   or streaming), including (we presume) to persons living in Illinois.
   Our question: How much, if any, of the royalties earned by the band members should be
   sourced to Illinois? With respect to the Illinois resident, this is not at issue, since he will pick up
   100% of all income to Illinois.

RULING
Your question concerns the manner in which Illinois taxes a nonresident partner with respect to his or
her distributive share of certain partnership royalty income.1 Section 305 of the Illinois Income Tax Act
(“IITA”; 35 ILCS 5/305) provides for the allocation or apportionment of a nonresident partner’s
distributive share of partnership income. The section states, in pertinent part, as follows:
§ 305. Allocation of Partnership Income by partnerships and partners other than residents. (a)
Allocation of partnership business income by partners other than residents. The respective
shares of partners other than residents in so much of the business income of the partnership
as is allocated or apportioned to this State in the possession of the partnership shall be taken
into account by such partners pro rata in accordance with their respective distributive shares of
such partnership income for the partnership's taxable year and allocated to this State.
(b) Allocation of partnership nonbusiness income by partners other than residents. The
respective shares of partners other than residents in the items of partnership income and
deduction not taken into account in computing the business income of a partnership shall be
taken into account by such partners pro rata in accordance with their respective distributive
shares of such partnership income for the partnership's taxable year, and allocated as if such
items had been paid, incurred or accrued directly to such partners in their separate capacities.
(c) Allocation or apportionment of base income by partnership. Base income of a partnership
shall be allocated or apportioned to this State pursuant to Article 3, in the same manner as it is
allocated or apportioned for any other nonresident.
Section 1501(a)(1) of the IITA defines the term “business income” as follows:
Business income. The term “business income” means all income that may be treated as
apportionable business income under the Constitution of the United States. Business income
is net of the deductions allocable thereto. Such term does not include compensation or the
deductions allocable thereto. For each taxable year beginning on or after January 1, 2003, a
taxpayer may elect to treat all income other than compensation as business income. This
election shall be made in accordance with rules adopted by the Department and, once made,
shall be irrevocable.
Under IITA Section 1501(a)(13), nonbusiness income is defined as all income other than business
income or compensation.
Under Article 3 of the IITA, base income that constitutes nonbusiness income is allocated to Illinois
under IITA Sections 301(c)(2) and 303. Base income that constitutes business income is apportioned
to Illinois under IITA Section 304. IITA Section 304(a) provides that for taxable years ending on or
after December 31, 2000, the apportionment factor for a taxpayer deriving business income from
Illinois and one or more other states (other than an insurance company, financial organization, or
transportation company) shall be equal to its sales factor. Section 304(a)(3)(A) defines the sales
factor as a fraction, the numerator of which is the total sales of the person in Illinois during the taxable
year, and the denominator of which is the total sales of the person everywhere. IITA Section
304(a)(3)(B-1) defines the numerator of the sales factor with respect to gross receipts from patents,
copyrights, trademarks, and similar items of intangible personal property. The section provides:

Note that Illinois also imposes an entity level tax on a partnership. 35 ILCS 5/201(c) and (d). The tax is imposed on the “net income”
of the partnership at the rate of 1.5% (35 ILCS 5/202).
1

(B-1) Patents, copyrights, trademarks, and similar items of intangible personal property.
(i) Gross receipts from the licensing, sale, or other disposition of a patent, copyright,
trademark, or similar item of intangible personal property, other than gross receipts governed
by paragraph (B-7) of this item (3), are in this State to the extent the item is utilized in this
State during the year the gross receipts are included in gross income.
(ii) Place of utilization.
(I) A patent is utilized in a state to the extent that it is employed in production, fabrication,
manufacturing, or other processing in the state or to the extent that a patented product is
produced in the state. If a patent is utilized in more than one state, the extent to which it is
utilized in any one state shall be a fraction equal to the gross receipts of the licensee or
purchaser from sales or leases of items produced, fabricated, manufactured, or processed
within that state using the patent and of patented items produced within that state, divided by
the total of such gross receipts for all states in which the patent is utilized.
(II) A copyright is utilized in a state to the extent that printing or other publication originates in
the state. If a copyright is utilized in more than one state, the extent to which it is utilized in any
one state shall be a fraction equal to the gross receipts from sales or licenses of materials
printed or published in that state divided by the total of such gross receipts for all states in
which the copyright is utilized.
(III) Trademarks and other items of intangible personal property governed by this paragraph
(B-1) are utilized in the state in which the commercial domicile of the licensee or purchaser is
located.
(iii) If the state of utilization of an item of property governed by this paragraph (B-1) cannot be
determined from the taxpayer's books and records or from the books and records of any
person related to the taxpayer within the meaning of Section 267(b) of the Internal Revenue
Code, 26 U.S.C. 267, the gross receipts attributable to that item shall be excluded from both
the numerator and the denominator of the sales factor.
In addition, IITA Section 304(a)(3)(B-2) states:
(B-2) Gross receipts from the license, sale, or other disposition of patents, copyrights,
trademarks, and similar items of intangible personal property, other than gross receipts
governed by paragraph (B-7) of this item (3), may be included in the numerator or denominator
of the sales factor only if gross receipts from licenses, sales, or other disposition of such items
comprise more than 50% of the taxpayer's total gross receipts included in gross income during
the tax year and during each of the 2 immediately preceding tax years; provided that, when a
taxpayer is a member of a unitary business group, such determination shall be made on the
basis of the gross receipts of the entire unitary business group.
Based on the information you have provided, it appears that the royalty income of the partnership
constitutes business income. Such income should be apportioned to Illinois applying the rules of IITA
Section 304, including the provisions set forth above. Under IITA Section 305, the nonresident
partners must include in their Illinois net income their distributive shares of the partnership’s business
income apportioned to Illinois.
In addition, note that IITA Section 709.5 imposes a withholding obligation with respect to a
nonresident partner’s distributive share. That section states, in pertinent part, as follows:

(a) In general. For each taxable year ending on or after December 31, 2008, every partnership
(other than a publicly traded partnership under Section 7704 of the Internal Revenue Code or
investment partnership), Subchapter S corporation, and trust must withhold from each
nonresident partner, shareholder, or beneficiary … an amount equal to the sum of (i) the share
of business income of the partnership, Subchapter S corporation, or trust apportionable to
Illinois plus (ii) for taxable years ending on or after December 31, 2014, the share of
nonbusiness income of the partnership, Subchapter S corporation, or trust allocated to Illinois
under Section 303 of this Act (other than an amount allocated to the commercial domicile of
the taxpayer under Section 303 of this Act) that is distributable to that partner, shareholder, or
beneficiary under Sections 702 and 704 and Subchapter S of the Internal Revenue Code,
whether or not distributed, (iii) multiplied by the applicable rates of tax for that partner,
shareholder, or beneficiary under subsections (a) through (d) of Section 201 of this Act, and
(iv) net of the share of any credit under Article 2 of this Act that is distributable by the
partnership, Subchapter S corporation, or trust and allowable against the tax liability of that
partner, shareholder, or beneficiary for a taxable year ending on or after December 31, 2014.
(b) Credit for taxes withheld. Any amount withheld under subsection (a) of this Section and
paid to the Department shall be treated as a payment of the estimated tax liability or of the
liability for withholding under this Section of the partner, shareholder, or beneficiary to whom
the income is distributable for the taxable year in which that person incurred a liability under
this Act with respect to that income.

As stated above, this is a GIL. A GIL 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 have questions regarding
this GIL you may contact Legal Services at (217) 782-2844. If you have further questions related to
Illinois income tax laws, visit our website at www.revenue.state.il.us or contact the Department’s
Taxpayer Information Division at (217) 782-3336.

Sincerely,

Brian L. Stocker
Staff Attorney (Income Tax)