For Illinois sales-factor sourcing purposes, is a taxpayer that regularly originates loans to customers still a 'dealer in securities' even though it qualifies for the federal negligible-sales exemption from mark-to-market accounting?

Plain-English summary

This Illinois Private Letter Ruling addresses a Delaware limited partnership that originates senior secured loans directly to middle-market U.S. companies (borrowers with less than $25 million in EBITDA), earning interest income that it reports as ordinary income on its federal Form 1065. The taxpayer asked the Illinois Department of Revenue whether it should be treated as a "dealer in securities" for purposes of sourcing that interest income under the Illinois sales factor, given that it qualifies for a federal regulatory exemption from dealer status.

Under federal tax law, a taxpayer that regularly originates loans to customers in the ordinary course of business meets the definition of a "dealer in securities" under 26 U.S.C. § 475(c)(1), which normally triggers mandatory mark-to-market accounting. However, Treas. Reg. § 1.475(c)-1(c)(1) exempts a taxpayer from dealer status (and from mark-to-market accounting) if it engages in no more than "negligible sales" of the loans/securities it originates and does not elect to be treated as a dealer anyway. The taxpayer here qualified for that negligible-sales exemption and had not elected out of it, and asked whether that federal exemption also took it out of "dealer" status for Illinois sourcing purposes.

The Department ruled that it does not. Illinois sources interest and other income from intangible personal property differently depending on dealer status: if the taxpayer is a "dealer in the item ... within the meaning of Section 475 of the Internal Revenue Code," the income is sourced to the customer's state of residence or commercial domicile (35 ILCS 5/304(a)(3)(C-5)(iii)(a)); if not, it is sourced based on where the taxpayer's income-producing activity occurs (subparagraph (b)). The Department reasoned that whether a taxpayer elects out of the federal negligible-sales exemption should not change which Illinois sourcing rule applies, since in either case the taxpayer is earning interest by making loans to customers in the ordinary course of business. Accordingly, a taxpayer eligible for the Treas. Reg. § 1.475(c)-1(c)(1) exemption is treated as a dealer in securities for Illinois sales-factor purposes whether or not it actually elects out of that federal exemption.

The practical result: this taxpayer's loan interest income goes into the numerator of its Illinois sales factor if the borrower/customer is an Illinois resident or has an Illinois commercial domicile (or, absent actual knowledge, if the customer's billing address on the dealer's records is in Illinois) -- not based on where the taxpayer performed its lending or loan-servicing activities.

What this means for you

Lenders, loan originators, and specialty finance companies

If your business regularly originates loans (or other debt instruments treated as securities under 26 U.S.C. § 475(c)(2)) to customers in the ordinary course of business, Illinois may treat you as a "dealer" for sales-factor sourcing purposes even if you qualify for the federal negligible-sales exemption from mark-to-market accounting and never elect out of it. That means your interest income could be sourced to Illinois based on customer location (residence, commercial domicile, or billing address) rather than on where your lending activity takes place -- a materially different sourcing test that can change your Illinois apportionment percentage.

Accountants and tax professionals

The key analytical point in this ruling is that the Department decoupled the Illinois "dealer" sourcing question from the taxpayer's federal election choice under Treas. Reg. § 1.475(c)-1(c)(1). A client's eligibility for (rather than actual use of) the negligible-sales exemption is enough to trigger dealer treatment under 35 ILCS 5/304(a)(3)(C-5)(iii)(a). When advising clients that originate loans or other debt obligations in Illinois or to Illinois customers, confirm whether they meet the 26 U.S.C. § 475(c)(1) dealer definition regardless of their mark-to-market election, since that -- not the election -- drives which Illinois sourcing subparagraph applies.

Business owners considering a PLR request

This ruling shows the Department will apply the customer-based sourcing rule to a lending business even where the business does not use mark-to-market accounting federally. If your fact pattern differs (for example, different levels of sales activity, a different entity structure, or an actual election under Treas. Reg. § 1.475(c)-1(c)(1)(ii)), you cannot assume this ruling covers you -- see the reliance question below.

Common questions

Q: Does qualifying for the federal "negligible sales" exemption mean a loan originator is not a dealer for Illinois tax purposes?
A: No. The Department ruled that a taxpayer eligible for the Treas. Reg. § 1.475(c)-1(c)(1) exemption is still considered a "dealer in securities" for purposes of Illinois's sales-factor sourcing rule, 35 ILCS 5/304(a)(3)(C-5)(iii)(a), regardless of whether it elects out of the exemption.

Q: How is the loan interest income sourced under this ruling?
A: As dealer income, it is sourced to Illinois if the customer is an individual, trust, or estate resident in Illinois, or if the customer's commercial domicile is in Illinois; absent actual knowledge of the customer's residence or domicile, the customer's billing address on the dealer's records controls.

Q: Can another taxpayer rely on this ruling?
A: No. This is a Private Letter Ruling issued under 2 Ill. Adm. Code 1200.110, and it binds the Department only with respect to the specific taxpayer who requested it, and only to the extent the facts that taxpayer presented were correct and complete. No other taxpayer -- even one in an apparently similar lending business -- can rely on it, and it can cease to bind the Department if the law changes or the underlying facts turn out to be inaccurate.

Q: What would change the outcome for a similar lender?
A: The ruling's conclusion rests on the taxpayer's specific facts: it regularly originates loans directly to customers, is engaged in that as a trade or business, and meets the 26 U.S.C. § 475(c)(1) dealer definition but for the negligible-sales exemption. A taxpayer that does not regularly originate loans to customers, that is not otherwise a "dealer" under Section 475(c)(1), or that has different sales volume, would need its own analysis (or its own PLR request) rather than relying on this one.

Citations and references

Statutes and regulations:

• 35 ILCS 5/304(a)(3)(A) (Illinois Income Tax Act — sales factor defined)
• 35 ILCS 5/304(a)(3)(C-5)(iii) (sourcing of interest and other intangible-property income; dealer vs. non-dealer rules)
• 26 U.S.C. § 475(a), (b), (c)(1) (federal mark-to-market accounting and "dealer in securities" definition)
• Treas. Reg. § 1.475(c)-1(c)(1) (negligible-sales exemption from dealer status)
• 2 Ill. Adm. Code 1200.110 (Private Letter Ruling procedure, including binding effect limited to the requesting taxpayer)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2018.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2018/it-18-0007-plr.pdf

Original ruling text

IT 18-0007-PLR 11/29/2018 2018 SALES FACTOR -INTANGIBLE PROPERTY
Taxpayer originating loans to customers in ordinary course of business is Dealer
November 29, 2018
Re:

Request for Private Letter Ruling
TAXPAYER
FEIN: ####

Dear Xxxxx:
This is in response to your letter dated June 12, 2018 in which you request a Private Letter
Ruling on behalf of TAXPAYER. Review of your request for a Private Letter Ruling indicates
that all information described in paragraphs 1 through 8 of subsection (b) of 2 Ill. Adm. Code
1200.110 is contained in your request. This Private Letter Ruling will bind the Department
only with respect to TAXPAYER. Issuance of this ruling is conditioned upon the
understanding that TAXPAYER and/or any related taxpayer(s) is not currently under audit
or involved in litigation concerning the issues that are the subject of this ruling request.
The facts and analysis as you have presented states as follows:
On behalf of our client, TAXPAYER (FEIN: ####), hereinafter referred to as “Taxpayer”), we
respectfully request the issuance of a private letter ruling (“PLR”) by the Illinois Department
of Revenue (“Department”) pursuant to 2 Ill Adm. Code 1200.110.
General Information

1. This PLR is not requested for hypothetical or alternatively proposed transactions; but
   rather to determine the income tax consequences of an actual transaction engaged in by
   Taxpayer, as described below.
2. Taxpayer is not currently engaged in litigation with the Department with regard to this or
   any other tax matter.
3. The Department has not previously ruled regarding this matter for Taxpayer. Neither
   Taxpayer nor TAX PRACITIONER has submitted the same or similar issue to the
   Department on behalf of Taxpayer.
4. We are aware of no authority contrary to the authorities referred to and cited below.
   Statement of Facts
   Taxpayer is a Delaware limited partnership established to provide partners with current
   income and long-term capital appreciation. This is achieved primarily by originating senior
   secured loans directly to North American middle market companies. The taxpayer serves as
   a senior secured lender primarily to U.S. companies with less than $25 million EBITDA which
   require financing to fund corporate events such as a buyout, recapitalization, ownership
   transfer, sourcing of expansion and capital growth or refinancing.

IT 18-0007-PLR
Page 2
Taxpayer is managed by COMPANY (hereinafter “COMPANY”). Through COMPANY’s
management, the taxpayer has access to an asset management and origination platform,
which includes a national transaction sourcing network. It is noteworthy that while the
taxpayer is not directly subject to regulation as an investment company, COMPANY is
subject to regulation by the United States Securities and Exchange Commission as a
Registered Investment Advisor.
Taxpayer is actively engaged in the business of originating and investing in senior secured
loans and is treated as such for federal income tax purposes. Accordingly, under the Internal
Revenue Code interest income earned by the taxpayer is treated as ordinary income and
included on its Form 1065. Taxpayer generates interest income in Illinois and other states
from loans secured by assets located across the United States.
By statute, Taxpayer would be considered a dealer in securities for federal income tax
purposes. However, the taxpayer qualifies for an exemption under Treas. Reg. 1.475(c)1(c). This regulation provides a taxpayer with an exception from using the mark-to-market
method of accounting. Taxpayer is trying to determine if it would still be considered a dealer
for Illinois Income Tax purposes, and thus, allowed to apportion its income under Illinois
Income Tax Act 304(a)(3)(C-5)(iii)(a).
Requested Rulings
Though Taxpayer is not a dealer for federal income tax purposes because of the regulatory
exemption under Treas. Reg. 1.475(c)-1(c), Taxpayer is otherwise a dealer as defined by
26 USC 475 and thus is considered a dealer for purposes of Illinois Income Tax Act
304(a)(3)(C-5)(iii)(a)?
Analysis
Illinois has various methods of sourcing interest income; the sourcing depends upon whether
the taxpayer is classified as a dealer within the meaning of 26 USC 475. If the taxpayer is
not a dealer, interest income is sourced to Illinois if the taxpayer’s income-producing activity
is performed in Illinois. However, if the taxpayer is a dealer, 35 ILCS 5/304(a)(3)(C-5)(iii)(a)
states:
“in the case of a taxpayer who is a dealer in the item of intangible property within the
meaning of Section 475 of the Internal Revenue Code, the income or gain is received
from a customer in this State. For purposes of this subparagraph, a customer is in
this State if the customer is an individual, trust or estate who is a resident of this State
and, for all other customers, if the customer’s commercial domicile is in this State.
Unless the dealer has actual knowledge of the residence or commercial domicile of
a customer during the taxable year, the customer shall be deemed to be a customer
in this State if the billing address of the customer, as shown in the records of the
dealer, is in this State.”
In looking to federal tax law, Section 475(c)(1) of the Internal Revenue Code (“Code”)
defines a “dealer in securities” as a taxpayer who:

IT 18-0007-PLR
Page 3
(A)
(B)

regularly purchases securities from or sells securities to customers in the ordinary
course of a trade or business; or
regularly offers to enter into, assume, offset, assign, or otherwise terminate positions
in securities with customers in the ordinary course of a trade or business.

In the ordinary course of business, Taxpayer originates loans directly with customers, that
is, Taxpayer makes loans by advancing cash in exchange for debt obligations of its
customers. As Taxpayer regularly originates loans to customers, Taxpayer meets the
definition of a “dealer in securities” as defined in the Code.
In general, Section 475 of the Code requires a dealer in securities to use a mark-to-market
method of accounting. By regulatory grace, however, the IRS effectively provides a taxpayer
with an exception (by not viewing the taxpayer as a dealer) from this mark-to-market
accounting if the taxpayer does not engage in more than “negligible sales” of securities it
has originated to customers. (Treas. Reg. 1.475-1(c)(1)(i)).
A taxpayer with “negligible sales” nonetheless may elect out of this regulatory exemption by
filing its return using the mark-to-market method of accounting described in Section 475(a).
(Treas. Reg. 1.475(c)-1(c)(1)(ii))
In summary, Taxpayer meets the definition of a “dealer in securities” as defined by the Code.
Taxpayer, however, qualifies for a regulatory exemption not to use the mark-to-market
method of accounting. Since taxpayer would technically meet the dealer definition under
475(c) but for the exemption, the rule allows them to elect dealer status if they want it. As a
result, it would appear Taxpayer could still be considered a dealer for Illinois income tax
purposes.
Conclusion
If the Taxpayer is not a dealer because they qualify for the exemption under Treas. Reg.
1.475(c)-1(c), the taxpayer would still be considered a dealer for purposes of IITA
304(a)(3)(C-5)(iii)(a).
We respectfully request a private letter ruling from the Department regarding this matter.
Should you disagree with this opinion, please contact me to discuss this opinion prior to
issuing a ruling. If you have any further questions or require any additional information,
please contact me.

RULING
Section 304(a)(3)(A) of the Illinois Income Tax Act (“IITA” ; 35 ILCS 5/304(a)(3)(A)) defines
the sales factor for taxpayers other than insurance companies, financial organizations,
federally regulated exchanges, and transportation companies, as follows:
The sales factor is a fraction, the numerator of which is the total sales of the person in this
State during the taxable year, and the denominator of which is the total sales of the person
everywhere during the taxable year.

IT 18-0007-PLR
Page 4
IITA Section 304(a)(3)(C-5) provides, in part, that, for taxable years ending on or after
December 31, 2008, sales, other than sales governed by paragraphs (B), (B-1), (B-2), (B-5)
and (B-7), are in this State if any of the following criteria are met:
(iii) In the case of interest, net gains (but not less than zero) and other items of income from
intangible personal property, the sale is in this State if:
(a) in the case of a taxpayer who is a dealer in the item of intangible personal
property within the meaning of Section 475 of the Internal Revenue Code, the
income or gain is received from a customer in this State. For purposes of this
subparagraph, a customer is in this State if the customer is an individual, trust
or estate who is a resident of this State and, for all other customers, if the
customer’s commercial domicile is in this State. Unless the dealer has actual
knowledge of the residence or commercial domicile of a customer during a
taxable year, the customer shall be deemed to be a customer in this State if
the billing address of the customer, as shown in the records of the dealer, is in
this State; or
(b) in all other cases, if the income-producing activity of the taxpayer is performed
in this State or, if the income-producing activity of the taxpayer is performed
both within and without this State, if a greater proportion of the incomeproducing activity of the taxpayer is performed within this State than any other
state, based on performance costs.
Section 475 of the Internal Revenue Code (IRC) prescribes use of the mark-to-market
accounting method for dealers in securities. Section 475(c)(1) defines a “dealer in securities”
to mean a taxpayer who:
(A)

regularly purchases securities from or sells securities to customers in the
ordinary course of a trade or business; or

(B)

regularly offers to enter into, assume, offset, assign or otherwise terminate
positions in securities with customers in the ordinary course of a trade or
business.

Section 475(a) requires that a dealer in securities apply the mark-to-market method of
accounting. Section 475(b) allows for exceptions to mark-to-market accounting for dealers,
providing that subsection (a) shall not apply to certain securities held by a dealer including:
(B)(i) any security described in subsection (c)(2)(C) which is acquired (including originated)
by the taxpayer in the ordinary course of a trade or business of the taxpayer and which is
not held for sale, and (ii) any obligation to acquire a security described in clause (i) if such
obligation is entered into in the ordinary course of such trade or business and is not held for
sale.
Pursuant to these provisions, Treas. Reg. § 1.475(c)-1(c)(1) provides for the following
exemption from dealer status:

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A taxpayer that regularly purchases securities from customers in the ordinary course of a
trade or business (including regularly making loans to customers in the ordinary course of a
trade or business of making loans) but engages in no more than negligible sales of the
securities so acquired is not a dealer in securities within the meaning of section 475(c)(1)
unless the taxpayer elects to be so treated or, for purposes of section 471, the taxpayer
accounts for any security (as defined in section 475(c)(2)) as inventory.
Under IITA Section 304(a)(3)(C-5)(iii), whether interest, net gains, and other items of income
from intangible personal property are assigned to Illinois for sales factor purposes depends
on whether the taxpayer “is a dealer in the item of intangible personal property within the
meaning of Section 475 of the Internal Revenue Code.” If the taxpayer is a dealer within the
meaning of IRC Section 475, the gross receipts are assigned to Illinois if the customer is in
Illinois. If the taxpayer is not a dealer within the meaning of IRC Section 475, the gross
receipts are assigned to Illinois under Section 304(a)(3)(C-5)(iii)(b) if the income-producing
activity is in Illinois. For this purpose, a taxpayer is a dealer with respect to an item of
intangible personal property if the taxpayer is actually a dealer with respect to the item under
IRC Section 475, or would be a dealer with respect to the item under IRC Section 475 if the
item were a security as defined in IRC Section 475(c)(2).
Your letter represents that the Taxpayer derives interest income by making loans to
customers in the ordinary course of its trade or business. You represent that the Taxpayer
is not a dealer in securities within the meaning of IRC Section 475(c)(1) by virtue of the
exemption allowed under Treas. Reg. § 1.475(c)-1(c)(1) to taxpayers who make only
negligible sales of loans that they originate and who do not elect out of the exemption. The
particular sourcing rule under IITA Section 304(a)(3)(C-5)(iii) to be applied should not
depend on whether a taxpayer does or does not elect out of the dealer exemption available
under Treas. Reg. 1.475(c)-1(c)(1). In either case, the taxpayer earns interest by making
loans to customers in the ordinary course of its trade or business. Accordingly, for purposes
of IITA Section 304(a)(3)(C-5)(iii), a taxpayer who is eligible for the exemption under Treas.
Reg. 1.475(c)-1(c)(1) is considered a dealer in securities with respect to loans it originates
to customers whether or not the taxpayer elects out of the exemption. In this case, then,
Taxpayer must include the interest income from loans made to its customers in the
numerator of its Illinois sales factor under IITA Section 304(a)(3)(C-5(iii)(a) if the customer
is a resident of Illinois or its commercial domicile is in this State.
This ruling shall bind the Department as provided herein. The facts upon which this ruling is
based are subject to review by the Department during the course of any audit, investigation
or hearing and this ruling shall bind the Department only if the material facts as recited and
incorporated in this ruling are correct and complete. This ruling shall bind the Department
for all taxable years, except as limited pursuant to 2 Ill. Adm. Code 1200.110(d) and (e).This
ruling will cease to bind the Department if there is a pertinent change in statutory law, case
law, rules or in the material facts recited in this ruling.
Sincerely,

Brian L. Stocker
Chairman, PLR Committee (Income Tax)