I took a lump-sum retirement distribution and claimed Net Unrealized Appreciation (NUA) treatment, but I also have a federal net loss carryforward that offset the NUA gain on my federal return -- does that net loss carryforward stop me from subtracting the NUA on my Illinois return?

Plain-English summary

A retired taxpayer took a lump-sum distribution from an employer retirement plan and used Net Unrealized Appreciation (NUA) treatment on employer securities included in that distribution. Under Illinois's Publication 120 guidance, NUA gains reported on U.S. Form 1040 or 1040-SR, Line 7 can be subtracted from federal AGI on Line 5 of the Illinois IL-1040. The taxpayer's complication: in the same year the NUA gain arose, they also had a federal net loss carryforward that offset the gain, so their federal return showed a net loss rather than a clean NUA gain. Worried that this offsetting loss might disqualify the NUA subtraction (and that skipping the subtraction in that year would mean losing the benefit forever, since the loss carryforward would not reappear in a later year), the taxpayer asked the Department to confirm which approach was correct before amending their return.

The Department's answer: the net loss carryforward doesn't matter. Section 203(a)(2)(F) of the Illinois Income Tax Act (35 ILCS 5/203(a)(2)(F)) allows a subtraction for amounts included in federal AGI that are described in IRC Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), and 408 (among other retirement-related provisions). The 2019 Form IL-1040 Instructions and Publication 120 both confirm that NUA gains on employer securities from a lump-sum distribution -- to the extent they are due to net unrealized appreciation at the time of distribution and reported on U.S. Form 1040 or 1040-SR, Line 7 -- qualify for this subtraction. The Department reviewed the taxpayer's own worked examples and agreed that the taxpayer's "last example" (taking the subtraction in the year the NUA was realized, regardless of the net loss carryforward reported that same year on the federal return) was the correct approach. It stated plainly that "the net loss carryforward you describe does not appear to affect the application of Section 203(a)(2)(F)."

The practical result. Because the taxpayer had not taken the subtraction on their original return (having sought this ruling first), the Department told them that if the NUA they realized meets the statutory requirements, they may file a 2019 Form IL-1040X to amend their return and include the NUA subtraction on Line 5.

What the Department didn't decide. As a GIL, this letter doesn't bind the Department and doesn't verify the taxpayer's specific dollar figures or confirm that every detail of the described distribution qualifies -- it addresses the narrow legal question of whether a net loss carryforward defeats NUA subtraction eligibility, and answers that it does not.

What this means for you

Retirees who took an NUA distribution in a loss year

If you had a lump-sum distribution with NUA treatment on employer securities, and that same tax year happened to include an offsetting net loss (from a carryforward or otherwise) that reduced or eliminated the visible gain on your federal return, you are not automatically disqualified from the Illinois subtraction. The subtraction is tied to the NUA gain being included in federal AGI and reported on Line 7 of Form 1040/1040-SR -- not to whether your bottom-line federal income for that year happened to be positive.

If you skipped the subtraction while waiting on a ruling

This taxpayer didn't claim the subtraction on their original return because they wanted certainty first. The Department confirmed that filing an amended return (Form IL-1040X) is the correct path to claim the subtraction retroactively for the affected year, provided the NUA otherwise meets the requirements.

Accountants and tax professionals

When a client's NUA gain is entangled with a net operating loss or loss carryforward in the same year, don't assume the offsetting loss changes the Illinois subtraction analysis. Check Publication 120 and the Line 5 instructions, confirm the NUA amount is properly reported on federal Line 7, and document that reporting when advising on an amended Illinois return.

Common questions

Q: Does a federal net loss carryforward disqualify me from Illinois's NUA subtraction?
A: No. The Department confirmed that a net loss carryforward does not affect eligibility for the Section 203(a)(2)(F) subtraction on NUA gains.

Q: What has to be true for NUA gains to qualify for the Illinois subtraction?
A: The gains must be due to net unrealized appreciation on employer securities at the time of a lump-sum distribution, reported on U.S. Form 1040 or 1040-SR, Line 7, and included in your federal AGI (which flows to IL-1040 Line 1).

Q: I didn't take the subtraction on my original Illinois return -- can I still get it?
A: Yes, if the NUA meets the requirements, the Department indicated you can file a Form IL-1040X to amend your return and claim the subtraction on Line 5.

Q: Is this letter binding on the Department for other taxpayers?
A: No. This is a General Information Letter, which provides general guidance but is not a statement of Department policy and is not binding, even for the requesting taxpayer. A binding answer would require a Private Letter Ruling request under 2 Ill. Adm. Code 1200.110.

Citations and references

Statutes, regulations, and guidance:

• 35 ILCS 5/203(a)(2)(F) (subtraction for certain retirement-related distributions, including NUA)
• Internal Revenue Code Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), 408 (referenced retirement distribution provisions)
• Internal Revenue Code Section 1402 (net earnings from self-employment, referenced regarding retired-partner payments)
• 2019 Form IL-1040 Instructions, Step 3, Line 5 (reporting the retirement-income subtraction)
• Illinois Department of Revenue Publication 120: Retirement Income

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/it23-0010-gil.pdf

Original ruling text

IT-23-0010-GIL 06/06/2023 SUBTRACTIONS
Federal net loss carryforward does not affect eligibility for Section (a)(2)(F)
subtraction modification for realized NUA benefit. (This is a GIL).
June 6, 2023
NAME/ADDRESS
Re: Illinois income tax
Dear NAME:
This is in response to your letter dated August 17, 2020, in which you request
additional information regarding Illinois income tax. 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.
Your letter states as follows:
Per my email conversation with NAME., I am writing to request a letter
ruling. I retired in YEAR and took advantage of the Net Unrealized
Appreciation (NUA). Per my understanding of Pub 120, I can reduce my
Federal AGI by my NUA using line 5 of the IL 1040 (Pub 120 states I can
reduce the following income on line 5 of my IL 1040 “capital gains on
employer securities received in a lump-sum distribution, to the extent the
gains are due to net unrealized appreciation on the securities at the time
of distribution and reported on your U.S. 1040 or 1040-SR, Line 6.").
Completing IL-4644 seems to confirm that I can reduce my federal AGI by
my NUA. However, because I have a net loss carryforward from YEAR,
my US 1040 line 6 is ($$$$). So, I was advised to obtain a letter ruling
before I deduct my NUA on my IL line 5. Therefore, I did not deduct it on
my original IL return.
I am contending that by not deducting it, I will forever lose the NUA
benefit, in my case $$$$. The NUA is included in my income on my IL
1040 line 1. It is just being offset by the net loss carryforward. Here is the
simplified example I provided to NAME that he suggested I send to you.
Supposed my wife and my wages total $$$$$ for YEAR, YEAR, and
YEAR. Suppose we have a net loss in YEAR of $$k. In YEAR we have
an NUA gain of $$k. No gain or loss in YEAR. Thus, on my Fed return for
YEAR, I report a net loss of $$$$, and an AGI of $$$$$. Same with YEAR
(as I have a net loss carryforward of $$$$ and an NUA gain of $$$$, for a
reported NL of $$$$). Then in YEAR, my AGI would be $$$$. Thus, my 3
year Fed AGI total is $$$$k ($$k from YEAR, $$$k form YEAR, and $$$k
from YEAR). If I can't report the $$k on line 5 of my IL taxes for YEAR,

then my IL line 9 income would be identical to my Fed AGI, for a 3-year
total taxable income for both of $$$$. So, I never get the benefit of
reducing my Fed AGI by the $$k NUA. This is illustrated in the first
section of the attached excel spreadsheet.
If the IRS would have allowed me to take the entire $$k loss in YEAR, my
AGI's would be $$k for YEAR, $$$k for YEAR, and $$$k for YEAR for the
same $$$k. Then my IL line 9 totals would be $$k, $$$k (the $$$k AGI
less the $$k NUA) and $$$k for a total of $$$k (thus I receive the $$k NUA
benefit). Please see the second section of the excel spreadsheet.
If I get to take the $$k NUA in YEAR for IL (despite reporting a NL in
YEAR), my Fed reporting would be $$k, $$k, and $$$k, again totaling
$$$k. However, my IL reporting on line 9 would be $$k, $$k, and $$$k for
a total of $$$$k, allowing me the $$k NUA benefit. So, the only way I get
the NUA benefit is if I take it for YEAR, despite the NOL I am reporting on
my Fed return for YEAR (Third section of the excel spreadsheet).
(Excel Spreadsheet removed)
RULING
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 istributions
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. (Emphasis added)
Step 3, Line 5 on page 7 of the 2019 Form IL-1040 Instructions (“2019
Instructions”) states, in pertinent part, as follows:
Line 5 Social Security benefits and certain retirement plans…Enter the
amount of federally taxed Social Security and retirement income included
in your adjusted gross income on Form IL-1040, Line 1 that you received
from…certain capital gains on employer securities reported on federal
Form 1040 or 1040-SR, Line 6.

2

Page 2 of Illinois Department of Revenue Publication 120: Retirement Income
(“Publication 120”), states, in pertinent part, as follows:
You may subtract the amount of any federally taxed portion (not the gross
amount) included in your Form IL-1040, Line 1 that you received from…
capital gains on employer securities received in a lump-sum distribution, to
the extent the gains are due to net unrealized appreciation on the
securities at the time of distribution and reported on your U.S. 1040 or
1040-SR, Line 7.
Based on the examples you provided, your last example appears correct.
According to Section 203(a)(2)(F), the 2019 Instructions and Publication 120, any
gains due to net unrealized appreciation (“NUA”) on employer securities received
in a lump-sum distribution reported on your U.S. 1040 or 1040-SR, Line 7, which
are included in your AGI, are eligible for the subtraction modification afforded by
Section 203(a)(2)(F). The net loss carryforward you describe does not appear to
affect the application of Section 203(a)(2)(F). Therefore, if, as described, the
NUA you realized meets these requirements, you may file a 2019 Form IL-1040X and include the NUA on Line 5.
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 regarding this letter, you may contact me at (217) 7822844.
Sincerely,
Michael D. Mankowski
Associate Counsel - Income Tax
cc:

Daily File
Correspondence file:

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