How should an out-of-state LLC report Illinois business income and nonbusiness rental loss passed through by lower-tier partnerships?

Plain-English summary

The out-of-state LLC had to keep the lower-tier partnerships' income character and Illinois sourcing instead of combining the amounts as nonbusiness income on Schedule NB. One Schedule K-1-P reported $2,091,233 of net business income apportioned 100% to Illinois. Under Section 305(a), the LLC had to report that amount as Illinois partnership business income rather than run it through its own apportionment factor.

The other Schedule K-1-P reported $212 of nonbusiness interest and an $11,312 rental loss. The interest was allocated outside Illinois based on the LLC's commercial domicile, while the real-property rental loss was allocated to Illinois. Assuming the K-1-Ps were correct and those partnership interests were the LLC's only Illinois connection, IDOR computed Illinois net income of $2,079,921.

The LLC also had to pass the Illinois business income and rental loss through to its own partners with the same character and sourcing. The Illinois business income ordinarily would have been subject to pass-through withholding, although IDOR said not to file an original or amended withholding return at that point because the partners had already filed and their adjustments would be handled directly.

What this means for you

Enter lower-tier partnership business income, nonbusiness income, and Illinois-sourced amounts on the designated upper-tier return lines. Do not relabel lower-tier business income as nonbusiness income or apply the upper-tier entity's own factor to income already apportioned by the lower-tier partnership.

Common questions

Q: Did the LLC apply its own apportionment factor to the $2,091,233?
A: No. The lower-tier partnership had already apportioned that business income 100% to Illinois.

Q: Was the $212 of nonbusiness interest Illinois income?
A: No, under the assumed out-of-state commercial domicile.

Q: What was Illinois net income under IDOR's assumptions?
A: $2,079,921—the $2,091,233 Illinois business income reduced by the $11,312 Illinois rental loss.

Citations and references

• 35 ILCS 5/301(c)(2)
• 35 ILCS 5/303(c)(1)
• 35 ILCS 5/305(a), (b)
• Form IL-1065, Schedule K-1-P, Schedule NB, and Form IL-1000

Subject

Partnership

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2011.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2011/it-11-0003.pdf

Original ruling text

IT 11-0003-GIL 02/04/2011 PARTNERSHIP
General Information Letter: Discussion of correct computation and apportionment of
partnership’s Illinois net income.
February 4, 2011
Dear:
The original and amended returns you prepared for COMPANY1 LLC for its 2008 taxable year have
been forwarded to me for review. Based on my review, it appears to me that you do not understand
the basic structure of Illinois income taxation of partners and partnerships, as reflected in the Form IL1065, Partnership Replacement Tax Return, the Schedule K-1-P, Partner’s or Shareholder’s Share of
Income, Deductions, Credits, and Recapture, and their instructions. As a result, the net income and
tax liability reported on these forms is incorrect.
In your letter dated February 23, 2010, you state that COMPANY1 LLC is based in STATE, and has
invested in several real estate partnerships, including two that are located in Illinois. The amended
returns includes copies of Schedules K-1-P provided to COMANY1 LLC by COMPANY2 LLC and
COMPANY3, LLC, for 2008, and I assume those are the two partnerships.
The Schedule K-1-P from COMPANY2 LLC reports various items of business income and
modifications for special depreciation. The net amount of these items is $2,091,233, and Line 4 of
the Schedule K-1-P indicates that 100% of these amounts should be apportioned to Illinois. The
Schedule K-1-P from COMPANY3, LLC shows $212 in nonbusiness interest income and a $11,312
nonbusiness rental loss. The rental loss is allocated to Illinois in the Schedule K-1-P. As a general
rule, partners may rely on the accuracy of Schedules K-1-P they receive and, for purposes of this
letter, I assume that these schedules are correct.
Section 305 of the Illinois Income Tax Act (35 ILCS 5/305) provides, in part:
(a) Allocation of partnership business income by partners other than residents.
The respective shares of partners other than residents in so much of the business
income of the partnership as is allocated or apportioned to this State in the possession
of the partnership shall be taken into account by such partners pro rata in accordance
with their respective distributive shares of such partnership income for the partnership's
taxable year and allocated to this State.
(b) Allocation of partnership nonbusiness income by partners other than
residents. The respective shares of partners other than residents in the items of
partnership income and deduction not taken into account in computing the business
income of a partnership shall be taken into account by such partners pro rata in
accordance with their respective distributive shares of such partnership income for the
partnership's taxable year, and allocated as if such items had been paid, incurred or
accrued directly to such partners in their separate capacities.
Under Section 305(a), and as shown in the Schedule K-1-P provided by COMPANY2 LLC, 100% of
COMPANY1 LLC’s $2,091,233 share of the net business income of COMPANY2 LLC should be
allocated to Illinois by COMPANY1 LLC.
Under Section 305(b), COMPANY1 LLC’s share of each item of nonbusiness income of COMPANY3,
LLC, should be allocated as if COMPANY1 LLC had received that item directly. The Schedule K-1-P

IT 11-0003-GIL
February 4, 2011
Page 2
from COMPANY3, LLC, indicates that no interest is allocable to Illinois. This is consistent with
Section 301(c)(2) of the Illinois Income Tax Act (35 ILCS 5/302), which provides that nonbusiness
interest is allocated to the commercial domicile of a taxpayer that is a partnership. The Schedule K-1P from COMPANY3, LLC, also indicates that all of the rental loss is allocated to Illinois, which would
be correct if the rental loss is from real property located in Illinois. See Section 303(c)(1) of the Illinois
Income Tax Act (35 ILCS 5/303).
The Schedule NB, Nonbusiness Income, attached to both the original and amended returns reports a
total of $2,142,657 in nonbusiness income allocable to Illinois. This matches the amounts of some
(but not all) items of income and modifications reported on the Schedules K-1-P from COMPANY1
LLC by COMPANY2 LLC and COMPANY3, LLC. Because of this match, and your statement that
COMPANY1 LLC is based in STATE, I assume that the items passed through from these
partnerships are the only Illinois-sourced items of COMPANY1 LLC. Even disregarding the
omissions, the Schedule NB is incorrect because the amounts passed through by COMPANY2 LLC
are business income, not nonbusiness income, and should not be reported on the Schedule NB.
Also, the $212 in nonbusiness interest income from COMPANY3, LLC, should not be allocated to
Illinois. When these corrections are made, the Schedule NB should show only $11,312 in rental loss
COMPANY3, LLC, as allocated to Illinois.
In Step 6 of the Form 1065, the statutory provisions for allocation of a partner’s income passed
through from a partnership are implemented as follows. First, on line 37, any nonbusiness income
passed through from a partnership will be subtracted from base income, along with any other
nonbusiness income of the partner. Accordingly, the $11,100 in net nonbusiness income from
COMPANY3, LLC, should have been reported here. Second, on line 38, any business income
passed through by a partnership should be subtracted. This would include the entire $2,091,233 from
COMPANY2 LLC. The remainder on Line 40 would be the business income earned by the partner
directly, and would be multiplied by the partner’s own apportionment factor on Line 43 to compute the
partner’s Illinois business income on Line 44. Then any nonbusiness income allocated to Illinois on
the Schedule NB would be included on Line 45 and the partner’s share of any business income
apportioned to Illinois by a partnership (and reported as such on the Schedule K-1-P from the
partnership) would be included on Line 46, and the two would be added to the taxpayer’s Illinois
business income to compute total Illinois-sourced income.
If the only connection between COMPANY1 LLC and Illinois is its interest in COMPANY2 LLC and
COMPANY3, LLC, the precise amounts that should be reported on Lines 37 and 38 are not relevant.
Whatever business income remains on Line 40 will not be apportioned to Illinois, because
COMPANY1 LLC would have no Illinois sales on Line 42. Also, the only Illinois nonbusiness income
on Line 45 would be the $11,312 rental loss reported by COMPANY3, LLC, and the only Illinois
partnership business income on Line 46 would be the $2,091,233 from COMPANY2 LLC, as reported
on its Schedule K-1-P.
Accordingly, if the Schedules K-1-P are correct and COMPANY1 LLC has no other connection with
Illinois, its Illinois net income should be $2,079,921.
This framework should also have been followed by COMPANY1 LLC in preparing the Schedules K-1P for its partners. The entire $2,091,233 in business income from COMPANY2 LLC should be
divided amount the partners and reported as Illinois-sourced business income on the Schedules K-1P provided to them. Similarly, the $11,312 in nonbusiness rental loss would be divided among the

IT 11-0003-GIL
February 4, 2011
Page 3
partners and reported as nonbusiness loss allocable to Illinois by the partners on the Schedules K-1P.
Finally, the $2,091,233 in business income sourced to Illinois would be subject to pass-through
withholding on the Form IL-1000, Pass-through Entity Payment Income Tax Return. Nonbusiness
income or loss is not taken into account on that form.
If this all makes sense to you, please prepare a new amended return reporting the correct amounts.
You may send it directly to me. There is no need to file an original or amended pass-through
withholding return at this point, since the partners should have long since filed their own returns with
Illinois, any adjustments to their liabilities will be worked out with them directly after we are certain
that we have properly determined the Illinois income of COMPANY1 LLC.
If you have any questions, please do not hesitate to call me at the number above or write to me. My
email address is [email protected].
Sincerely,

Paul S. Caselton
Deputy General Counsel – Income Tax