What does Illinois Private Letter Ruling IT 19-0003-PLR conclude about Apportionment - Sales Factor?

Plain-English summary

An S corporation that had operated in Illinois for over eighty years sold all of its stock to a third-party buyer, and the parties jointly elected under federal Section 338(h)(10) to treat the sale as if the corporation had sold all of its assets rather than its shareholders selling stock. The taxpayer asked the Illinois Department of Revenue three things: whether Illinois would follow the federal deemed-asset-sale treatment, whether the resulting gain counted as "business income" for Illinois apportionment purposes, and whether the huge one-time receipts from that deemed sale would inflate the company's sales factor (and therefore its Illinois tax) the same way ordinary sales revenue would.

The Department said yes to the first two points and no to the third. It agreed that a valid Section 338(h)(10) election causes the transaction to be treated as a deemed sale of assets for Illinois Income and Replacement Tax purposes, consistent with federal treatment. Because the taxpayer elected under 35 ILCS 5/1501(a)(1) to treat all of its income as "business income," the gain on the deemed sale was business income subject to Illinois apportionment via the sales factor under 35 ILCS 5/304(a) and 304(h).

The key relief came on the sales-factor mechanics. The Department held that the gross receipts from the deemed sale were an "incidental or occasional sale of assets used in the regular course of the person's trade or business" under 86 Ill. Adm. Code 100.3380(c)(2), because the taxpayer represented that no similar sale had ever occurred in its history and the sale disposed of essentially the whole business. That regulation excludes such receipts from both the numerator and denominator of the sales factor, so the one-time sale of the entire business did not distort the ongoing apportionment ratio used to tax the company's regular operations.

Like all PLRs, this ruling rests entirely on the specific facts the taxpayer presented — an eighty-year-old S corporation, a single unprecedented liquidity event via stock sale with a 338(h)(10) election, and no history of similar asset dispositions. The Department expressly noted the ruling binds it only as to this taxpayer and only if the facts recited were correct and complete, and that it automatically expires ten years after issuance under 2 Ill. Adm. Code 1200.110(e).

What this means for you

Business owners contemplating a stock sale with a 338(h)(10) election

If your company (especially an S corporation) is selling all of its stock and the buyer wants a Section 338(h)(10) election, this ruling shows how Illinois can treat the resulting gain: it follows the federal deemed-asset-sale characterization, and if the gain is business income, it flows through the sales factor — but the receipts from that one-time, whole-business sale may be excludable from the sales factor as an "occasional sale," which can meaningfully reduce apportioned tax compared to including the full sale price in the denominator and numerator.

Accountants and tax professionals

The ruling walks through the interaction of several IITA provisions: the business-income election under 35 ILCS 5/1501(a)(1), the sales-factor-only apportionment regime under 35 ILCS 5/304(h), and the occasional-sale carve-out in 86 Ill. Adm. Code 100.3380(c)(2). It's a useful illustration of how the Department applies the occasional-sale exclusion to a deemed asset sale under IRC 338(h)(10), not just to a literal asset sale like a factory or plant (the regulation's own example).

Corporate sellers and their advisors

The favorable outcome depended on specific facts: the taxpayer had never before sold an interest in any of its subsidiary or joint-venture entities, and other intangible-asset sales were only a minor part of its business. If your client's transaction history includes recurring asset sales, the "incidental or occasional" characterization may be harder to sustain, and you should not assume this ruling extends to a different fact pattern.

Common questions

Q: Does Illinois follow the federal Section 338(h)(10) deemed-asset-sale treatment?
A: Yes, according to this ruling. The Department agreed that if the taxpayer made the election for the relevant tax year, the sale of its stock would be treated as a deemed sale of its assets for Illinois Income and Replacement Tax purposes, consistent with the federal treatment.

Q: Is the gain from the deemed sale included in the sales factor?
A: No. The Department ruled that because the deemed sale was an incidental or occasional sale of substantially all the business's assets, and no similar sale had occurred before, the gross receipts are excluded from both the numerator and denominator of the sales factor under 86 Ill. Adm. Code 100.3380(c)(2), even though the gain itself is treated as business income.

Q: Can I rely on this ruling for my own transaction?
A: No, not directly. This is a Private Letter Ruling issued under 2 Ill. Adm. Code 1200.110, and it binds the Department only as to the specific taxpayer who requested it, and only to the extent the facts that taxpayer presented were correct and complete. Other taxpayers can look to it as an illustration of the Department's reasoning, but they cannot rely on it as authority for their own situation, and it automatically expires ten years after issuance.

Q: What happens if a company has sold similar assets before?
A: This ruling doesn't answer that directly, but it emphasizes as a material fact that the taxpayer had never previously sold an interest in any of its other entities and that other intangible-asset sales were only a minor part of its business. A history of repeated similar sales could undercut the "incidental or occasional" characterization needed for the sales-factor exclusion.

Citations and references

Statutes and regulations:

• 35 ILCS 5/304(a), (f), (h) (apportionment of business income and the sales factor)
• 35 ILCS 5/1501(a)(1) (election to treat all income as business income)
• 35 ILCS 5/1501(a)(21) (definition of "sales" for the sales factor)
• 86 Ill. Adm. Code 100.3380(c)(2) (occasional-sale exclusion from the sales factor)
• 26 U.S.C. 338(h)(10) (federal deemed-asset-sale election)
• 2 Ill. Adm. Code 1200.110 (Private Letter Ruling procedure and ten-year expiration)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2019.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2019/it19-0003-plr.pdf

Original ruling text

IT-19-0003-PLR 08/12/2019 APPORTIONMENT - SALES FACTOR
Private Letter Ruling: Receipts from deemed sale of assets comprising entire business are
excluded from the sales factor as being from an occasional sale.
August 12, 2019
Re:

COMPANY

Dear Xxxx:
This is in response to your letter dated December 20, 2018, in which you requested a Private Letter
Ruling on behalf of COMPANY. Review of your request for a Private Letter Ruling disclosed that all
information described in paragraphs 1 through 8 of subsection (b) of 2 Ill. Adm. Code Section 1200.110
appears to be contained in your request. The Private Letter Ruling will bind the Department only with
respect to COMPANY for the issue or issues presented in this ruling. Issuance of this ruling is
conditioned upon the understanding that neither COMPANY nor a related taxpayer is 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 them are as follows:
In accordance with 2 Ill. Adm. Code 1200.110 (the “Regulation”), we are submitting this letter
to the Illinois Department of Revenue (“Department”) to request consideration of a Private
Letter Ruling on behalf of our client, COMPANY (the “Taxpayer”). We respectfully request the
Department’s consideration of the Taxpayer’s situation and our conclusions regarding its
recent transaction. Please let us know if further information is required regarding the below or
if you have questions. Once you have reviewed this request, we would appreciate the
opportunity to discuss this matter with you. In due course, the Taxpayer intends to disclose its
identity as required by the Regulation and, correspondingly, we will provide our power of
attorney for the Taxpayer.
I.

Qualification of Taxpayer for a Private Letter Ruling under the Regulation

1. This Private Letter Ruling is made for a specific tax type, Illinois Income and
   Replacement Tax.
2. This Private Letter Ruling is not requested with regard to hypothetical or alternative
   proposed transactions.
3. This Private Letter Ruling is for a single, specific taxpayer.
4. The Taxpayer is not currently under audit by or in litigation with the Department in
   regard to this or any other tax matter.
5. To the best of our knowledge and the knowledge of the taxpayer, our understanding
   is that the Department has not previously ruled on the same or a similar issue for the
   taxpayer or a predecessor, nor has any prior request been submitted and withdrawn
   with respect to this matter.

II. Statement of Contrary Authorities

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The Taxpayer has determined that there are no authorities contrary to its views, or at
least the Taxpayer has been unable to locate any such authorities.
III. Request for Deletion of Names and Identifying Information

The Taxpayer requests that its name, the names of any other parties, and the name of
its representative be redacted in the publicly disseminated version of any Private Letter
Ruling issued. The Taxpayer also requests that the reference to any state other than
Illinois be redacted along with the names of any foreign countries. The Taxpayer is
unaware of any other “specific trade secret information” included in this request.
IV. Relevant Contracts, Licenses, Agreements, Instruments or Other Documents

The Taxpayer, in due course, intends to provide the Department with any documentation
necessary to consider this request. We expect that the specific documents needed will be
identified during discussions with the Department.
V. Statement of the Material Facts

1. Background on Taxpayer
   The Taxpayer was formed as a corporation in Illinois over eighty years ago. It has
   undertaken the primary business of manufacturing and selling its tangible goods. For
   federal income tax purposes, the Taxpayer elected status as an S Corporation under
   Subchapter S of the Internal Revenue Code (the “Code”). The Taxpayer went through a
   recent transaction (the “Transaction”), described in further detail below. At the time of the
   Transaction, the Taxpayer had ## shareholders (the “Shareholders”). Each of the
   Shareholders was a trust entity, but for federal income tax purposes the income and
   deductions were reported on individual tax returns, Form 1040. Many of the Taxpayer’s
   owners also held a corporation (“Company A”) which held real property in State A, on
   which the Taxpayer’s only domestic manufacturing facility was located. Company A also
   held property in State B, and the Taxpayer used this as a facility pursuant to a 10-year
   lease which was prepaid. The Taxpayer also held ##% interests in each of three separate
   joint ventures with facilities located in three different foreign countries.
   In Illinois, the Taxpayer maintained a sales, warehouse and administrative facility which
   it leased from a third party. In State A, the Taxpayer maintained its domestic
   manufacturing facility for tangible goods and it also packaged these goods there. The
   Taxpayer’s research and development departments were based at the State A facility. In
   State B, the Taxpayer maintained a sales, packaging, warehouse and administrative
   facility. In addition, the Taxpayer stores inventory in public warehouses in twelve other
   states and ships its goods to customers from these public warehouses.

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The Taxpayer’s senior management has been primarily based at its Illinois location, at
least since it elected S Corporation status in 1987, other than a senior officer who was
based at the State B location up through the end of 2017. Taxpayer has filed Form 1120S,
U.S. Income Tax Return for an S Corporation, with the Internal Revenue Service.
Taxpayer has filed Form IL- 1120-ST, Small Business Corporation Replacement Tax
Return (“Form IL-1120-ST”) with the Department as required for prior tax years.

2. Specific Transaction
   On July XX, 2018, the Taxpayer along with its shareholders and a designated shareholder
   representative entered into a Share Purchase Agreement (the “Agreement”) with
   Company Z (the “Buyer”). The Buyer was a third party to the Taxpayer and its
   shareholders. Under the Agreement, Buyer agreed to purchase all of the shares of stock
   in the Taxpayer and to make a joint election under Section 338(h)(10) of the Code. In
   addition, the Taxpayer transferred interests in the three foreign joint ventures to the Buyer
   or its designee, as described below. The Agreement was in negotiation for months
   preceding the Agreement date. The process of reviewing a potential transaction and the
   ultimate decision to enter into the Agreement, and to make a Section 338(h)(10) election
   for the transaction, was undertaken by the State B senior officer, who acted as President
   of the Taxpayer up through the end of 2017 and was a also a director, and two other
   officers/directors of the Taxpayer, one a resident of Illinois and the other a resident of a
   state other than Illinois.
   On September #, 2018, the Transaction was initiated, so control over the business
   operations and business assets were transferred to the Buyer. In exchange for closing
   payments by the Buyer, the Taxpayer’s shareholder representative delivered all stock
   interests in the Taxpayer to the Buyer. Immediately prior to the Transaction, the Taxpayer
   purchased from Company A the real property it used in State A. Regarding the three
   foreign joint ventures, for the two joint ventures in which the Buyer was already the other
   50% owner, the Taxpayer transferred its 50% interest to the Buyer or its designee. For the
   third foreign joint venture, the Taxpayer acquired the outside 50% interest just prior to the
   Transaction, so this also fully transferred to the Buyer or its designee.
   Since the Taxpayer elected S Corporation status in 1987, it had not previously sold an
   interest in any other of the entities in which it has held an interest. Any other sales of
   intangible assets were only a minor part of the Taxpayer’s business, as the Taxpayer’s
   primary business focus was on the sales of the goods that it manufactured.
   On its Form IL-1120-ST for the tax year ending on the date of the Transaction, the
   Taxpayer will make an election under 35 ILCS 5/1501(a)(1) to treat all of its income as
   “business income” for Illinois Income and Replacement Tax purposes.
   VI. Statement of Relevant Authorities and Ruling Requested

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1. Relevant Authorities
   Section 338(h)(10) of the Code allows a buyer to acquire stock of an S Corporation
   while treating the transaction as the acquisition of all of the S Corporation’s assets. The
   seller’s tax treatment is the sale of its tangible and intangible assets. This is commonly
   referred to a “deemed asset sale.”
   35 ILCS 5/203(b)(1) provides that “…[i]n the case of a corporation, base income means
   an amount equal to the taxpayer's taxable income for the taxable year as modified by
   paragraph (2).”
   35 ILCS 5/203(e)(2)(G) provides: “Subchapter S corporations. In the case of: (i) a
   Subchapter S corporation for which there is in effect an election for the taxable year
   under Section 1362 of the Internal Revenue Code, the taxable income of such
   corporation determined in accordance with Section 1363(b) of the Internal Revenue
   Code, except that taxable income shall take into account those items which are required
   by Section 1363(b)(1) of the Internal Revenue Code to be separately stated…”
   35 ILCS 5/102 states: “Construction. Except as otherwise expressly provided or clearly
   appearing from the context, any term used in this Act shall have the same meaning as
   when used in a comparable context in the United States Internal Revenue Code of 1954
   or any successor law or laws relating to federal income taxes and other provisions of
   the statutes of the United States relating to federal income taxes as such Code, laws
   and statutes are in effect for the taxable year.”
   35 ILCS 5/403(a) states: “Reporting. To the extent not inconsistent with the provisions
   of this Act or forms or regulations prescribed by the Department, each person making a
   return under this Act shall take into account the items of income, deduction and
   exclusion on such return in the same manner and amounts as reflected in such person's
   federal income tax return for the same taxable year.”
   35 ILCS 5/1501(a)(1) sets forth the statutory definition of the term “business income.”
   This section provides that 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.
   35 ILCS 5/304 sets forth the manner in which the business income of a corporation is
   apportioned between Illinois and one or more other states. 35 ILCS 5/304(h) states that
   for years ending on or after December 31, 2000, the business income of a corporation is
   apportioned by the sales factor. 35 ILCS 5/304(a)(3)(A) states that the sales factor is a

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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.
35 ILCS 5/304(f) states that if the allocation and apportionment provisions do not fairly
represent the market for the person’s goods, services, or other sources of business
income, the person may petition for, or the Director may, without a petition, permit or
require, in respect of all or any part of the person’s business activity, if reasonable: (4)
the employment of any other method to effectuate an equitable allocation and
apportionment of the person’s business income.
86 Ill. Admin. Code 100.3380(c)(2) is an exercise of the Department’s authority under
35 ILCS 5/304(f) and states that when gross receipts arise from an incidental or
occasional sale of assets used in the regular course of the person’s trade or business,
those receipts shall be excluded from the sales factor. For example, gross receipts from
the sale of a factory or plant will be excluded.
The Department has previously issued informal guidance in General Information Letter
No. IT 01-0043-GIL (May 2, 2001) stating that “Illinois does conform to the federal
treatment and rules attending an IRC section 338(h)(10) election.” In addition, the
Department has indicated in General Information Letter No. IT 07-0017-GIL that “…the
provisions of Code section 338(h)(10) apply in determining the base income of an S
corporation for Illinois replacement income tax purposes.”

2. Rulings Requested
   1) The Department will treat the sale of the Taxpayer’s stock as a deemed sale of its
   assets for Illinois Income and Replacement Tax purposes, consistent with the treatment for
   federal income tax purposes.
   2) The Department will treat all of the Taxpayer’s income, including income from the
   Transaction, as “business income” based on the Taxpayer’s business income election
   under 35 ILCS 5/1501(a)(1) as made on its Form IL-1120-ST for the tax year ending
   September XX, 2018.
   3) Other than for the sale of inventory and other assets which the Taxpayer has sold in
   the regular course of its business, 86 Ill. Admin. Code 100.3380(c)(2) would apply for
   sales factor purposes to exclude the incidental or occasional (deemed) sale of the
   assets that were used in the regular course of the Taxpayer’s trade or business.

Ruling of the Department
Section 338(h)(10) of the Code, 26 U.S.C. §338(h)(10) states in part:

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(10) Elective recognition of gain or loss by target corporation, together with nonrecognition of
gain or loss on stock sold by selling consolidated group.—
(A) In general.--Under regulations prescribed by the Secretary, an election may be
made under which if—
(i) the target corporation was, before the transaction, a member of the selling
consolidated group, and
(ii) the target corporation recognizes gain or loss with respect to the transaction
as if it sold all of its assets in a single transaction, then the target corporation
shall be treated as a member of the selling consolidated group with respect to
such sale, and (to the extent provided in regulations) no gain or loss will be
recognized on stock sold or exchanged in the transaction by members of the
selling consolidated group.
If the Taxpayer makes this election for the tax year ending September 30, 2018, the sale of the
Taxpayer’s stock will be treated as a deemed sale of its assets for the purposes of the Illinois Income
and Replacement taxes.
Section 304(a) of the Illinois Income Tax Act (the “IITA”; 35 ILCS 5/101 et seq.) provides:
[…] If a person other than a resident derives business income from this State and one or
more other states, then, for tax years ending on or before December 30, 1998, and except as
otherwise provided by this Section, such person's business income shall be apportioned to
this State by multiplying the income by a fraction, the numerator of which is the sum of the
property factor (if any), the payroll factor (if any) and 200% of the sales factor (if any), and the
denominator of which is 4 reduced by the number of factors other than the sales factor which
have a denominator of zero and by an additional 2 if the sales factor has a denominator of
zero. For tax years ending on or after December 31, 1998, and except as otherwise provided
by this Section, persons other than residents who derive business income from this State and
one or more other states shall compute their apportionment factor by weighting their property,
payroll, and sales factors as provided in subsection (h) of this Section.
Other apportionment formulas are provided in Section 304 of the IITA for insurance companies,
financial organizations, federally regulated exchanges, and transportation companies, but the facts
stated in your request indicate that the Taxpayer does not qualify to use any of these formulas.
Section 304(h)(3) of the IITA provides that, for taxable years ending on or after December 31, 2000,
only the sales factor shall be used to apportion business income under Section 304(a) of the IITA.
Section 304(f) of the IITA provides:
If the allocation and apportionment provisions of subsections (a) through (e) and of
subsection (h) do not, for taxable years ending before December 31, 2008, fairly

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represent the extent of a person's business activity in this State, or, for taxable years
ending on or after December 31, 2008, fairly represent the market for the person's
goods, services, or other sources of business income, the person may petition for, or
the Director may, without a petition, permit or require, in respect of all or any part of the
person's business activity, if reasonable:
(1) Separate accounting;
(2) The exclusion of any one or more factors;
(3) The inclusion of one or more additional factors which will fairly represent
the person's business activities in this State; or
(4) The employment of any other method to effectuate an equitable allocation and
apportionment of the person's business income.
Section 1501(a)(1) of the IITA provides:
[…]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.
If the Taxpayer makes this election for the tax year ending September 30, 2018, its gain on the sale
of the assets related to the Transaction, will be treated as business income, regardless of whether
the gains otherwise meet the definition of business income.
Section 1501(a)(21) of the IITA defines “sales” for purposes of the sales factor to include all gross
receipts of the taxpayer characterized as business income. However, pursuant to the authority
granted to the Director under Section 304(f) of the IITA, the Department has adopted 86 Ill. Adm.
Code Section 100.3380(c)(2), which provides:
Where gross receipts arise from an incidental or occasional sale of assets used in the regular
course of the person's trade or business, such gross receipts shall be excluded from the sales
factor. For example, gross receipts from the sale of a factory or plant will be excluded.
You have represented that the sale of the assets related to the Transaction is an incidental or
occasional sale of assets of the Taxpayer, and that no similar sale has occurred in the history of the
Taxpayer. Based on this representation, if the Taxpayer elects to treat all of its income for the tax year
ending on September 30, 2018 as business income, the gain on its sale of the assets related to the
Transaction is business income, the gain will be apportioned using the sales factor of the Taxpayer
under Section 304(a) of the IITA, and the gross receipts from the sale will be excluded from the
numerator and denominator of the sales factor under 86 Ill. Adm. Code Section 100.3380(c)(2).
The facts upon which this ruling are 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 in this ruling are correct and complete. 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.

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Pursuant to 2 Ill. Admin. Code Section 1200.110(e), this ruling is automatically revoked as of ten years
after the date of issuance, if not revoked earlier.
Sincerely,

Michael D. Mankowski
Associate Counsel - Income Tax