I'm an Illinois resident claiming the credit for taxes paid to other states on guaranteed payments allocated out of state -- do I really have to allocate my whole HSA deduction to those other states too, shrinking my credit?

Plain-English summary

An Illinois resident is a non-equity partner in a partnership and receives guaranteed payments for work he performs in Illinois for Illinois-based clients. Even so, some states where the partnership does business require the partnership to allocate a share of his guaranteed payments to those states based on the partnership's own apportionment percentage -- regardless of where he actually worked. As a result, he files nonresident returns in three other states and claims the Illinois resident credit for the taxes paid there. He also has an HSA deduction, which is a personal deduction unrelated to where his work income was earned. Illinois's Schedule CR, Credit for Tax Paid to Other States, requires that 100% of the HSA deduction be treated as allocated to non-Illinois income when figuring the credit limitation. The taxpayer's representative argued this was unfair: the taxpayer never actually deducted the HSA contribution on any of his nonresident state returns, so allocating it against out-of-state income on the Illinois credit computation gave him no tax benefit anywhere, even though he clearly incurred the expense as an Illinois resident.

The Department held that the current Schedule CR treatment is correct. The resident credit for taxes paid to other states, under 35 ILCS 5/601(b)(3), is capped by a fraction: the numerator is the taxpayer's base income that would be allocated or apportioned to other states if those states had adopted Illinois's own Article 3 allocation and apportionment rules, and the denominator is the taxpayer's total base income. The Department reasoned that the U.S. Supreme Court's decision in Lunding v. New York Tax Appeals Tribunal, 522 U.S. 287 (1998) -- which held that a state cannot discriminate against nonresidents by denying them a deduction (there, alimony paid) that it allows to its own residents -- means Illinois must assume other states would let a nonresident deduct amounts like alimony, and by the same logic, an HSA deduction, in full. So if Illinois's own allocation and apportionment rules were used, the HSA deduction would show up in the numerator of the fraction (i.e., "allocated" to the other states) just as it would be allowed to nonresidents filing an Illinois return. Because the credit limitation fraction is a hypothetical construct based on Illinois's own rules -- not a reflection of what other states actually let the taxpayer deduct -- the fact that the taxpayer got no actual state-tax benefit from the HSA deduction elsewhere is not something the statute accounts for. The Department therefore concluded the Schedule CR instructions "correctly apply the statute," and it noted that Illinois, consistent with the same logic, does let nonresidents filing Illinois returns allocate their full HSA deduction to Illinois.

What the Department didn't do. It did not create any exception for personal deductions unconnected to the income being allocated, and it did not revisit or reweigh the policy critique that the taxpayer's representative raised (that this produces no benefit anywhere for an expense the taxpayer clearly incurred). As a GIL, the letter simply explains how the existing statute and Lunding line of authority apply; it does not commit the Department to this result in any other taxpayer's case, and the Department expressly noted it is not bound by it.

What this means for you

Illinois residents with guaranteed payments or other income allocated out of state by a partnership

If a partnership allocates your compensation to other states based on the partnership's own apportionment percentage (rather than where you personally worked), and you claim the Illinois resident credit for taxes paid to those states, expect that personal deductions like an HSA deduction will be allocated 100% against that out-of-state income on Schedule CR -- reducing your credit -- even if you got no actual deduction benefit in the states where you filed nonresident returns.

Anyone with an HSA deduction and out-of-state sourced income

The HSA deduction's treatment here follows the same Schedule CR mechanics that already applied to the federal alimony deduction after Lunding. If you are a Illinois nonresident, you can allocate your full HSA deduction to Illinois when computing your Illinois net income; if you are an Illinois resident claiming a credit for taxes paid elsewhere, expect the reverse -- your HSA deduction will be allocated to the other state(s) for purposes of the resident credit's limitation fraction.

Accountants and tax professionals preparing Schedule CR for multistate partners

This GIL confirms the Department's position that Schedule CR's HSA-allocation instructions are correct and will not be revisited through a private ruling. If a client faces a similar apparent "no benefit anywhere" outcome, don't expect an exception -- the credit limitation fraction is calculated using Illinois's own hypothetical allocation rules, not the client's actual out-of-state tax treatment.

Common questions

Q: Do I have to allocate my HSA deduction against out-of-state income when computing the Illinois resident credit for taxes paid to other states?
A: Yes, according to this GIL -- the Department says the Schedule CR instructions requiring that allocation correctly apply 35 ILCS 5/601(b)(3), as informed by Lunding v. New York Tax Appeals Tribunal.

Q: Does it matter that I never actually deducted the HSA contribution on my nonresident state returns?
A: Not under the Department's reasoning here. The credit limitation fraction is based on what would be allocated to other states if those states had adopted Illinois's own Article 3 rules -- not on what those states actually allowed you to deduct.

Q: Why does the Lunding case matter to an HSA deduction?
A: Lunding held that a state can't deny nonresidents a deduction (there, alimony) that it gives residents. Illinois already lets nonresidents allocate deductions like alimony and, by the same reasoning, HSA contributions in full to Illinois. The Department says that same principle requires assuming other states would do likewise, so the HSA deduction is treated as allocated to those states in the credit limitation numerator.

Q: Is this letter binding on the Department in future cases?
A: No. This is a General Information Letter, not a Private Letter Ruling -- it is not a statement of Department policy and is not binding on the Department, even for taxpayers in a similar situation.

Citations and references

Statutes and cases:

• 35 ILCS 5/601(b)(3) (resident credit for taxes paid to other states; credit limitation fraction)
• 35 ILCS 5/203 (base income computation)
• Lunding v. New York Tax Appeals Tribunal, 522 U.S. 287 (1998)
• 11-0014-GIL and 20-0005-GIL (prior GILs applying Lunding to the alimony deduction)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2024.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2024/IT24-0005-GIL.pdf

Original ruling text

IT 24-0005-GIL 04/29/2024 ALLOCATION
General Information Letter: In computing the credit for taxes paid to other
states, residents are required to allocate credits to out-of-state income due
to the United States Supreme Court decision in Lunding v. New York Tax
Appeals Tribunal. (This is a GIL.)
April 29, 2024
NAME
OCCUPATION
ADDRESS
Re:

NAME
Allocation of HSA Deduction
Account ID: ########
Tax Year Ended: MM/DD/YEAR

Dear NAME:
This is in response to your letter dated August 4, 2023, in which you requested a
private letter ruling regarding the allocation of the Health Savings Account (HSA)
deduction on the Illinois Schedule CR, Credit for Tax Paid to Other States, as
non-Illinois sourced income.
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(b) and (c). 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 request and the information you have provided require that we
respond with a GIL. In your letter, you have stated and made inquiry as follows:
I am submitting this request for a private letter ruling on behalf of
my clients, NAME. Enclosed, please find a power of attorney
confirming I am authorized to submit this request on my clients’
behalf. The taxpayer is a non-equity partner in a partnership and
receives guaranteed payments as compensation for work
performed in Illinois for Illinois-based clients. At the partnership

NAME
Page 2
level, some states require guaranteed payments be allocated
based on the partnership’s apportionment percentage, regardless
of where the partner worked and earned their compensation. As a
result, some of his income has been allocated to other states.
Their YEAR Illinois tax return was filed claiming the resident credit
for taxes paid to other states for non-Illinois income. The taxpayers
also have a $$$$$ HSA deduction on their YEAR tax return. The IL
Schedule CR page 2 automatically requires that column B, NonIllinois portion, include the full amount of HSA deduction as nonIllinois sourced. This does not accurately represent the source or
character of the HSA deduction, as this is a personal deduction that
should be allocated to a taxpayer’s home state. For example, in an
instance where a taxpayer earned wages sourced to IL, had an
HSA deduction and had an out of state rental, the IL law currently
requires that the HSA deduction be allocated 100% to the out of
state rental income, thus reducing the out of state income by a HSA
deduction, even though the taxpayer would incur the $$$$$ HSA
expense regardless of having the out of state rental, and the
taxpayer would not deduct the HSA expense on the nonresident
return, due to it being an expense allocable to their resident state
since it is a personal expense. However, if the taxpayer merely had
W2 income and no resident credit for other state taxes paid, the
taxpayer will get the benefit of the HSA deduction against his IL
sourced wages. This HSA expense would exist regardless of
having an out of state rental and should not automatically be fully
allocated to out of state income sources, reducing the resident
credit.
In the taxpayers’ case specifically, NAME has guaranteed
payments from a partnership in which he is a non-equity partner.
Certain states require his partnership allocate his guaranteed
payments based on the partnership’s apportionment percentage,
even though his guaranteed payment is like a wage to him and he
has no equity ownership in the partnership. As a result, he files
returns in STATE1, STATE2, and STATE3 in addition to his home
state of Illinois. Illinois is currently requiring that he allocate 100% of
his HSA deduction to non-Illinois sources. However, this expense is
a personal expense, and has nothing to do with the income
allocated to other states. Additionally, the taxpayer did not deduct
any HSA expense to his nonresident states, so Illinois allocating it
to non-resident states results in the taxpayer getting no state tax
benefit from the deduction whatsoever. However, if NAME had no
out of state sourced income, he would get the benefit of his HSA
deduction. We believe the fair treatment would be to allocate the
HSA deduction to his home state of Illinois, since it is not related to

NAME
Page 3
his out of state income and is a personal expense, and he did not
deduct it on any nonresident returns. Since he contributed to his
HSA (a personal expense) while a resident of Illinois, this deduction
is clearly an Illinois deduction and should not be allocated to
nonresident states.
We see no authority that is to the contrary of our position.
According to 35 ILCS 5/203, base income for individuals is an
amount equal to the taxpayers federal AGI for the year, adjusted for
modifications listed in section 203(a)(2). There is no modification for
HSA deduction, and therefore, according to 35 ILCS 5/203, the
Illinois tax base for individuals allows for a deduction of the HSA
contributions. Illinois requiring that the HSA deduction be sourced
fully to nonresident states where the taxpayer did not get the
benefit of the deduction deprives the taxpayer from any benefit at
the state level and is contrary to the intent of 35 ILCS 5/203. The
current law does not accurately reflect the tax base for the
nonresident states, as it reduces the nonresident income by the
HSA deduction when it was not actually deducted on those
nonresident returns, as the taxpayer is not entitled to deduct an
expense that is personal and therefore related to his resident state
against nonresident income. Reducing the taxpayer’s out of state
income by the HSA deduction that they did not get to deduct on the
nonresident return is effectively disallowing the deduction in full for
the taxpayer, which does not align with the fact that Illinois
residents should be entitled to reduce their income by their HSA
contributions.
The current law requiring 100% of the HSA deduction to be
allocated to out of state income regardless of the percentage of out
of state income to in state income is inequitable, and it is not logical
to allocate a deduction for an expense that a taxpayer incurs
personally in full to reduce to out of state income that was not
reduced by the HSA contribution. We are requesting that the
treatment of HSA deductions for taxpayers claiming the resident
credit be reevaluated to allocate the HSA deduction in full to Illinois
for Illinois residents, or to at the very least allocate, it based on the
percentage of income earned in Illinois.
To the best of the knowledge of both the taxpayers and the
taxpayers’ representative, the Department has not previously ruled
on the same or similar issue for the taxpayer or a predecessor, and
the taxpayers and/or their representatives have not previously
submitted the same or a similar issue to the Department but
withdrew it before a letter ruling was issued.

NAME
Page 4
We appreciate your attention to this matter and the time taken to
consider our request.
RULING
Section 601(b)(3) of the Illinois Income Tax Act (IITA) (35 ILCS 5/601) allows
Illinois residents a credit for taxes paid to other states. That section provides, in
part:
The aggregate amount of tax which is imposed upon or measured by
income and which is paid by a resident for a taxable year to another state
or states on income which is also subject to the tax imposed by
subsections 201(a) and (b) of this Act shall be credited against the tax
imposed by subsections 201(a) and (b) otherwise due under this Act for
such taxable year.
………
For taxable years ending on or after December 31, 2009, the credit
provided under this paragraph for tax paid to other states shall not exceed
that amount which bears the same ratio to the tax imposed by subsections
201(a) and (b) otherwise due under this Act as the amount of the
taxpayer’s base income that would be allocated or apportioned to other
states if all other states had adopted the provisions in Article 3 of this Act
bears to the taxpayer’s total base income subject to tax by this State for
the taxable year. (Emphasis added.)
………
The credit provided by this paragraph shall not be allowed if any creditable
tax was deducted in determining base income for the taxable year. Any
person claiming such credit shall attach a statement in support thereof and
shall notify the Director of any refund or reductions in the amount of tax
claimed as a credit hereunder all in such manner and at such time as the
Department shall by regulations prescribe.
The italicized language above limits the amount of tax paid to other states that
may otherwise qualify for the credit. That limitation is determined by multiplying
the amount of Illinois income tax otherwise imposed for the taxable year by a
fraction, the numerator of which is the amount of the taxpayer’s base income that
would be allocated or apportioned outside of Illinois assuming that all other states
adopted Illinois’ allocation and apportionment rules as set forth in Article 3 of the
IITA, and the denominator of which is the taxpayer’s total base income for the
taxable year. Under this provision, only income that would have been taxable by
other states applying Illinois law is included in the numerator of the fraction
thereby increasing the credit limitation.

NAME
Page 5
In Lunding v. New York Tax Appeals Tribunal, 522 U.S. 287 (1998), the United
States Supreme Court held that states could not discriminate against
nonresidents by denying them the same deduction for alimony paid that would be
allowed to residents. Therefore,
nonresidents are allowed to allocate to Illinois the full amount of the federal
deduction for alimony paid in determining their Illinois net income. See 11-0014GIL and 20-0005-GIL. Consistent with this allocation, the limit on the credit for
taxes paid to other states in Section 601(b)(3) of the IITA must be computed by
allocating the deduction for alimony paid to other states as if they followed the
same allocation principles as Illinois.
The holding in Lunding similarly applies to the HSA deduction at issue here. As
a result, if any of the other states in which taxpayer filed a return had adopted
Article 3 of the IITA, the taxpayer’s HSA deduction would have been allowed in
full. Accordingly, the HSA deduction must be allocated to the other states in
computing the numerator of the taxpayer’s limitation fraction. Illinois allows
nonresidents to allocate the full amount of the HSA deduction to Illinois in
determining their Illinois net income. The instructions to the Illinois Schedule CR
correctly apply the statute.
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.
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
Assistance Division at (217) 782-3336.
Sincerely,
Jennifer Uhles
Associate Counsel (Income Tax)