Does a lump-sum payment that replaces years of scheduled retirement benefits stay exempt from Illinois income tax when a company sale forces early plan termination?

Plain-English summary

A husband and wife who file jointly asked the Illinois Department of Revenue to confirm, via a Private Letter Ruling, that a lump-sum retirement payment would stay exempt from Illinois income tax. The husband had retired from his employer and had been reporting a qualified retirement benefit payment on line 5 of Form IL-1040 as exempt "per Section 1402 of the Illinois Code," with scheduled payments set to continue until he turns 75 in 2036. His former employer was then sold, and as a result of the change in control, it planned to terminate the retirement plan and accelerate every remaining scheduled payment into one lump sum in a single tax year. The company pointed to two federal Treasury regulations -- 1.409A-3(j)(4)(ix)(b) and 1.409A-1(c)(2) -- as support for treating the lump sum as still exempt.

The Department did not give the confirmation requested. Instead, it corrected the legal basis of the request: Section 1402 of the Illinois Income Tax Act (35 ILCS 5/1402) actually addresses the Department's own notice requirements and does not appear to apply to the taxation of retirement income at all, meaning the taxpayer's prior returns had cited the wrong provision. The subtraction that actually governs retirement income is Section 203(a)(2)(F) of the IITA (35 ILCS 5/203(a)(2)(F)), which allows a deduction for amounts included in federal adjusted gross income under specific Internal Revenue Code provisions covering tax-exempt employee trusts, certain annuities, and IRAs (IRC Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), and 408), governmental-agency retirement or disability plans, or retired-partner payments excluded from self-employment earnings under IRC Section 1402.

The Department also noted that the two Treasury regulations the company cited appear to relate to nonqualified deferred compensation plans, and that, based on the information provided, it was unclear whether the husband's plan was qualified or nonqualified -- and therefore unclear whether any of the IRC provisions listed in Section 203(a)(2)(F) actually apply to these retirement benefits. The Department did not resolve that ambiguity. It stated the general rule instead: Illinois follows the federal treatment, and whether paid as a lump sum or as regular distributions, retirement income qualifies for the Section 203(a)(2)(F) subtraction only if it is included in gross income under one of those enumerated IRC provisions, or is a retired-partner payment excluded from self-employment earnings under IRC Section 1402. Nonqualified deferred compensation generally is not covered by those enumerated sections, so if this plan turns out to be a true nonqualified plan, the lump sum would likely not qualify -- but the Department left that determination open for lack of clarity on the plan's qualified/nonqualified status.

What this means for you

Retirees facing an accelerated or lump-sum payout

Do not assume a lump-sum payment automatically keeps the same Illinois tax treatment as the scheduled payments it replaces. The exemption depends on whether your specific plan is a "qualified" plan whose distributions fall under the IRC sections enumerated in Section 203(a)(2)(F) (402(a), 402(c), 403(a), 403(b), 406(a), 407(a), or 408). If your plan is a nonqualified deferred compensation arrangement -- the kind governed by Treasury Regulations 1.409A-3(j)(4)(ix)(b) and 1.409A-1(c)(2) -- the Illinois subtraction likely does not apply, regardless of whether the payment is exempt for other federal reasons.

HR and benefits professionals handling plan terminations

When a change in control forces plan termination and payment acceleration, the Section 409A rules that justify the federal timing of the lump sum do not by themselves establish Illinois income tax treatment. Confirm whether the terminated plan is qualified or nonqualified before telling affected employees how the accelerated payment will be taxed in Illinois.

Tax preparers for retirees

Check what your client's retirement plan actually is before applying the Section 203(a)(2)(F) subtraction to a lump-sum distribution. If prior returns cited Section 1402 of the Illinois Code as the basis for the exemption, that citation is likely incorrect, since Section 1402 concerns the Department's notice requirements, not retirement-income taxability. Verify eligibility under Section 203(a)(2)(F) directly, and confirm which IRC provision the distribution falls under.

Common questions

Q: Did the Department rule that the lump sum is exempt from Illinois income tax?
A: No. The Department declined to confirm exemption. It said it was unclear whether the plan is qualified or nonqualified, and that determination controls whether the Section 203(a)(2)(F) subtraction applies.

Q: Was the taxpayer's original citation to Section 1402 of the Illinois Code correct?
A: No. The Department stated that Section 1402 of the Illinois Income Tax Act (35 ILCS 5/1402) addresses the Department's own notice requirements and does not appear to apply to the taxation of retirement income.

Q: Does converting scheduled retirement payments into a lump sum change the Illinois tax analysis?
A: Not by itself. The Department said Illinois follows federal treatment regardless of whether retirement income is paid as a lump sum or in regular distributions -- the controlling question is whether the income falls under one of the enumerated IRC provisions in Section 203(a)(2)(F).

Q: Do the Treasury regulations the company cited (1.409A-3(j)(4)(ix)(b) and 1.409A-1(c)(2)) establish the Illinois exemption?
A: Not according to the Department. Those regulations govern nonqualified deferred compensation plans, and nonqualified deferred compensation generally is not covered by the IRC provisions enumerated in Section 203(a)(2)(F). If the plan is truly nonqualified, the subtraction likely would not apply.

Q: Can I rely on this GIL for my own situation?
A: No. A General Information Letter is not a statement of Department policy and is not binding on the Department. It merely points to relevant regulations and statutes; it does not resolve disputed facts, such as whether a specific plan is qualified or nonqualified.

Citations and references

Statutes and regulations:

• 35 ILCS 5/203(a)(2)(F) (IITA retirement-income subtraction modification)
• 35 ILCS 5/1402 (IITA, Department's notice requirements -- not applicable to retirement-income taxability)
• IRC Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), 408 (tax-exempt employee trusts, annuities, IRAs)
• IRC Section 1402 (net earnings from self-employment; retired-partner payments)
• Treas. Reg. 1.409A-3(j)(4)(ix)(b) (nonqualified deferred compensation plan termination/liquidation)
• Treas. Reg. 1.409A-1(c)(2) (nonqualified deferred compensation payment acceleration on change in control)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2023.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2023/it23-0005-gil.pdf

Original ruling text

IT-23-0005-GIL 05/31/2023 SUBTRACTIONS
Retirement income, including lump sum payment, is eligible for subtraction
modification under Section 203(a)(2)(F) of the IITA if it is included in federal
adjusted gross income pursuant to the provisions of the Internal Revenue Code
cited in Section 203(a)(2)(F).
May 31, 2023

NAME/ADDRESS
Dear NAME:

This letter is in response to your letter received by the Department on March 22,
2023, in which you requested information. The Department issues two types of letter
rulings. Private Letter Rulings (“PLRs”) are issued by the Department in response to
specific taxpayer inquiries concerning the application of a tax statute or rule to a
particular fact situation. A PLR is binding on the Department, but only as to the
taxpayer who is the subject of the request for ruling and only to the extent the facts
recited in the PLR are correct and complete. Persons seeking PLRs must comply with
the procedures for PLRs found in the Department’s regulations at 2 Ill. Adm. Code
1200.110. The purpose of a General Information Letter (“GIL”) is to direct taxpayers to
Department regulations or other sources of information regarding the topic about which
they have inquired. A GIL is not a statement of Department policy and is not binding on
the Department. See 2 Ill. Adm. Code 1200.120. You may access our website at
www.tax.illinois.gov to review regulations, letter rulings and other types of information
relevant to your inquiry.
The nature of your inquiry and the information you have provided require that we
respond with a GIL. In your letter you have stated and made inquiry as follows:
The purpose of this letter is to request a Private Letter Ruling
pursuant to I.A.C. Title 2, Chapter 1200.110 - Private Letter Rulings. The
request seeks a determination as to whether termination/ retirement
benefits scheduled over a number of years remain exempt from Illinois
Income Tax per Section 1402 of Illinois Code if they are accelerated to a
lump sum payment within a single tax year as the result of plan
termination due to a change in control of the company due to a sale.
Statement of Facts:
1.

The parties of interest with respect to this request are
HUSBAND and WIFE, husband and wife, who file jointly with
the Illinois Department of Revenue.

2.

HUSBAND was formerly employed by COMPANY1 and
retired as of MONTH DAY, YEAR.

HUSBAND
Page 2
May 31, 2023
3.

As part of the filings for tax years YEAR - YEAR, income
from a qualified retirement benefit payment from
COMPANY1 was noted on line 5 of the IL-1040 and is not
subject to Illinois Income Tax per Section 1402 of the Illinois
Code.

4.

A similar qualified retirement benefit payment will be noted
on the return for tax year YEAR, which is currently being
prepared.

5.

The qualified retirement benefit payments are currently
scheduled to continue until HUSBAND, retiree, reaches age
75 on December 31, 2036 (another 14 years).

Material Issues:
1.

COMPANY1 has notified HUSBAND, retiree, that the
company has entered into a Letter of Intent to sell the
company.

2.

COMPANY1 has notified HUSBAND, retiree, of their intent
to terminate the retirement plan and accelerate plan
payments due to the change in control.

3.

COMPANY1 has notified HUSBAND, retiree, of their intent
to pay all remaining scheduled payments with a single lump
sum payment in calendar year YEAR.

4.

COMPANY1 has cited U.S. Treas. Reg. 1.409A-3(j)(4)(ix)(b)
as the regulation that allows termination and liquidation and
U.S. Treas. Reg. 1.409A-l(c)(2) allowing payment
acceleration due to a change in control event.

5.

COMPANY1 has stated to HUSBAND, retiree, that the
citation above in Item 4 substantiates that a lump sum
payment of remaining scheduled benefits will remain exempt
from Illinois Income Tax provided the plan is terminated and
lump sum payment is made as a result of the change in
ownership control due to a sale.

Subject of Request:
1.

HUSBAND, retiree, is requesting a Private Letter Ruling from
IDOR that a lump sum payment, if made in the YEAR tax
year, of the remaining scheduled retirement benefits would

HUSBAND
Page 3
May 31, 2023
remain exempt from Illinois Income Tax if the plan is
terminated under the terms outlined.
Statements:
1.

There is currently no pending audit or litigation associated
with the taxpayer, HUSBAND.

2.

The Department has not previously ruled on the same or a
similar issue for the taxpayer, and taxpayer has not
previously submitted the same or similar issue to the
Department and withdrew it before a letter ruling was issued.

3.

COMPANY2 has stated that the accounting firm providing
services to COMPANY1 has provided them with the opinions
listed under 4 and 5 of Material Issues above. Taxpayer is
not aware of any other authority supporting those views.

4.

Taxpayer
has
not
been
able
to
authority/authorities contrary to those views.

5.

Taxpayer is not requesting any specific trade secret
information be deleted from the publicly disseminated
version of the Private Letter Ruling.

locate

any

DEPARTMENT’S RESPONSE:
Section 203(a)(2)(F) of the Illinois Income Tax Act (“IITA”, 35 ILCS
5/203(a)(2)(F)) provides the following deduction in the computation of an individual’s
Illinois base income:
An amount equal to all amounts included in such total pursuant to the provisions
of Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), and 408 of the Internal
Revenue Code, or included in such total as distributions under the provisions of
any retirement or disability plan for employees of any governmental agency or
unit, or retirement payments to retired partners, which payments are excluded in
computing net earnings from self employment by Section 1402 of the Internal
Revenue Code and regulations adopted pursuant thereto.
Section 402 of the Internal Revenue Code deals with distributions from employee
trusts exempt under Section 401(a) of the Internal Revenue Code, which provides an
exemption for certain employee trusts “created or organized in the United States.”
Section 403(a) of the Internal Revenue Code deals with annuities described in
Section 402(a)(2) of the Internal Revenue Code, which describes certain annuities

HUSBAND
Page 4
May 31, 2023
purchased by employee trusts exempt under Section 401(a) of the Internal Revenue
Code.
Section 403(b) of the Internal Revenue Code deals with annuities for employees
of exempt organizations.
Sections 406 and 407 of the Internal Revenue Code deal with employee benefit
plans under Section 401 that cover overseas employees of affiliates of the employer
that created the plan.
Section 408 of the Internal Revenue Code deals with individual retirement
accounts.
In paragraph 3 of your Statement of Facts, you state that “…income from a
qualified retirement benefit payment from COMPANY1 is noted on line 5 of the IL-1040
and is not subject to Illinois Income Tax per Section 1402 of the Illinois Code.” Section
1402 of the Illinois Income Tax Act, 35 ILCS 5/1402, addresses the Department’s notice
requirements and does not appear to apply to the treatment of retirement income. In
paragraph 4 of your Material Issues section, you refer to U.S. Treas. Reg. l.409A3(j)(4)(ix)(b) and U.S. Treas. Reg.1.409A-1(c)(2) which appear to apply to nonqualified
deferred compensation plans. Based on the information that you have provided, it is
unclear whether you are a member of a qualified or nonqualified plan or if any of the
provisions cited in Section 203(a)(2)(F) of the IITA apply to the retirement benefits at
issue.
That being said, the Department follows the federal treatment when determining
whether retirement income, whether it is made in a lump sum or as regular distributions,
is subject to the subtraction modification under Section 203(a)(2)(F). If the income is
included in gross income under Internal Revenue Code Sections 402(a), 402(c), 403(a),
403(b), 406(a), 407(a), or 408, or because it is a retirement payment to a retired partner,
which is excluded in computing net earnings from self employment by Section 1402 of
the Internal Revenue Code and regulations adopted pursuant thereto, then the income
qualifies for the Section 203(a)(2)(F) deduction.
I hope this information is helpful. If you require additional information, please
visit our website at www.tax.illinois.gov or contact the Department’s Taxpayer
Information Division at (217) 782-3336.
Very truly yours,
Michael D. Mankowski
Associate Counsel
MDM:CB-C