Could a nonresident use Illinois passive losses before federal law allowed them, and how were released losses sourced to Illinois?

Plain-English summary

Illinois followed federal timing for passive losses, then applied Illinois sourcing when the loss became deductible. Because Illinois base income started with federal adjusted gross income and contained no separate passive-loss modification, a loss disallowed under Section 469 was also disallowed for Illinois in that year.

When federal law later allowed the suspended loss, Illinois included it and sourced it under Article 3. A deduction tied to nonbusiness income was allocated with that income; a business loss was apportioned using the factor and method applicable to the business in the year the loss was allowed.

The GIL's example separately apportioned three passive businesses. Federal Form 8582 allowed parts of the current losses, and Illinois applied each activity's own sales factor rather than building a separate Illinois-only passive-loss pool.

What this means for you

Maintain suspended-loss records by activity and by federal release year. When a loss is finally allowed, retrieve the Illinois sourcing facts and apportionment factor for that year—not necessarily the year the loss originated.

The letter discussed filing liability generally but did not create an Illinois election or annual filing method to “preserve” a federally suspended loss.

Common questions

Q: Could Illinois deduct a passive loss disallowed federally?
A: No.

Q: When was a suspended loss sourced to Illinois?
A: In the year it became federally deductible, using the applicable Illinois allocation or apportionment rule.

Q: Did every passive activity use one combined Illinois factor?
A: Not in the example; the separate businesses used their own factors.

Citations and references

• 35 ILCS 5/203(h) — Illinois modifications only as expressly provided
• I.R.C. § 469 — federal passive-activity-loss limitation
• 35 ILCS 5/301(c)(2), 303, 304 — allocation and apportionment
• 35 ILCS 5/502(a) — nonresident filing requirement
• 86 Ill. Adm. Code 100.2410(a)(5), (b)(1) — passive deductions and later sourcing

Subject

Subtraction Modifications – Other Rulings

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2014.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2014/it-14-0008.pdf

Original ruling text

IT 14-0008-GIL 08/19/14 SUBTRACTION MODIFICATIONS – OTHER RULINGS
In computing base income, only passive losses deducted in computing the individual taxpayer’s federal
adjusted gross income are allowable, and passive loss deductions of a nonresident must be sourced to
Illinois according to the apportionment factors of the business that produces the losses. (This is a GIL.)
August 19, 2014
Re:

Illinois income tax

Dear Xxxx:
This is in response to your letter dated March 17, 2014, received by our office July 16, 2014. The nature
of your letter and the information provided require that we respond with a General Information Letter
(GIL). A GIL 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 accessed from
the Department’s web site at www.ILtax.com.
Your letter states as follows:
The primary purpose of this letter is to establish the Illinois nonresident filing requirements with
regard to the use of prior year passive losses to offset current year passive income/gain.

1. Can passive losses in excess of passive income from Illinois source activities be carried
   forward to future tax years to offset passive income/gain?
2. If so, what method should be employed to allocate these losses if there are multiple IL source
   passive activities? For example, can/should the taxpayer employ the Federal methodology,
   according to federal form 8582, using only Illinois source activities?
3. If the passive losses can be used to fully offset passive income/gain, is a tax return required to
   be filed each year to preserve the losses, or is it sufficient to maintain records of the losses which
   would be available for future use?

RULING
Section 502(a) of the Illinois Income Tax Act (“IITA”; 35 ILCS 5/502(a)) sets forth the requirements for
filing Illinois income tax returns. That section states in part as follows:
(a) In general. A return with respect to the taxes imposed by this Act shall be made by every
person for any taxable year:
(1)

For which such person is liable for a tax imposed by this Act, or

(2)
In the case of a resident or in the case of a corporation which is qualified to do business
in this State, for which such person is required to make a federal income tax return, regardless of
whether such person is liable for a tax imposed by this Act.

Under this section, a nonresident taxpayer must file an Illinois income tax return if the taxpayer incurs a
liability for tax imposed under Section 201 of the IITA (or in the case of a corporation qualified to do
business in Illinois, if it is required to file a federal return). A nonresident is generally liable for Illinois
income tax under Section 201 if it computes “Illinois net income” as defined under IITA Section 202.
IITA Section 202 defines Illinois net income as that portion of the taxpayer’s “base income,” as defined
in Section 203, which is allocated or apportioned to Illinois under the provisions of Article 3 of the
IITA, less certain deductions. The starting point in calculating base income under Section 203 is the
taxpayer's taxable income (or adjusted gross income in the case of an individual) for federal income tax
purposes. Taxable income (or adjusted gross income) is then modified by certain statutorily prescribed
addition and subtraction modifications in order to arrive at base income. Under IITA Section 203(h),
taxable income (adjusted gross income) is modified only as expressly provided in that section. The IITA
contains no modifications with respect to deductions disallowed under the passive activity rules under
IRC Section 469, nor does the IITA otherwise provide its own limitations on passive activity losses
attributable to Illinois activities. Therefore, passive activity deductions are allowed for Illinois purposes
to the extent allowed for federal income tax purposes. Passive activity deductions disallowed for federal
income tax purposes are likewise disallowed for Illinois income tax purposes. See 86 Ill. Adm. Code
§100.2410(a)(5). Passive activity losses allowed for federal income tax purposes are sourced according
to the provisions of Article 3 of the IITA.
Under Article 3 of the IITA, nonbusiness income, together with any item of deduction directly allocable
thereto, is allocated to Illinois under IITA Sections 301(c)(2) and 303. Business income is apportioned
to Illinois under IITA Section 304. Under IITA Section 1501(a)(1), the term “business income” is
defined as all income that may be treated as apportionable under the Constitution of the United States,
net of deductions allocable thereto. IITA Section 1501(a)(13) defines nonbusiness income as all income
other than business income or compensation income. IITA Section 304(a) provides for taxable years
ending on or after December 31, 2000, that the apportionment factor for a nonresident deriving business
income from Illinois and one or more other states (other than an insurance company, financial
organization, or transportation company) shall be equal to its sales factor. Section 304(a)(3)(A) defines
the sales factor as a fraction, the numerator of which is the total sales of the person in Illinois during the
taxable year, and the denominator of which is the total sales of the person everywhere. IITA Section
1501(a)(21) defines the term “sales” to mean all gross receipts of the taxpayer that are part of the
taxpayer’s business income.
The following example illustrates the application of the above provisions.
Assume nonresident Taxpayer earned $20,000 of wage income for the taxable year, none of which is
allocated to Illinois. In addition, taxpayer holds interests in passive activities A, B and C. The gross
income and deductions from these activities is as follows:

Gross income
Deductions
Net income (loss)

A
7,000
(16,000)
(9,000)

B
4,000
(20,000)
(16,000)

C
12,000
(8,000)
4,000

Total
23,000
(44,000)
(21,000)

Taxpayer’s ($21,000) passive activity loss for the taxable year is disallowed under IRC Section 469.
Taxpayer completes federal Form 8582 to determine that a ratable portion of the loss from activities A
and B is disallowed. The disallowed portion of the loss from Activity A is $7,560. The disallowed
portion of the loss from Activity B is $13,440.
Taxpayer’s adjusted gross income is $20,000, comprised as follows:
Wage income
Activity A
Activity B
Activity C
Gross income

$20,000
($1,440)
($2,560)
$4,000_
$20,000

Assume that Taxpayer has no addition or subtraction modifications, and that Activities A, B, and C are
separate trades or businesses the income of which must be apportioned separately under 86 Ill. Adm.
Code § 100.3010(b). Assume Activity A has an Illinois sales factor of 10%, Activity B has an Illinois
sales factor of $20%, and Activity C has an Illinois sales factor of 50%. Taxpayer’s Illinois net income
is computed as follows (disregarding any net operation loss deduction or standard exemption):

Wage income
Activity A
Activity B
Activity C
Illinois net income

Base Income
$20,000
($1,440)
($2,560)
$4,000

Illinois net income
$0
($144)
($512)
$2,000
$1,344

Note that the $7,560 disallowed loss from Activity A, and the $13,440 disallowed loss from Activity B,
will be allocated to Illinois in the taxable year in which the losses are allowed for federal income tax
purposes according to the sales factor (or other allocation method) applicable for that taxable year. See
86 Ill. Adm. Code § 100.2410(b)(1).
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. If you have questions regarding this
GIL you may contact Legal Services at (217) 782-7055. If you have further questions related to Illinois
income tax laws, visit our website at www.revenue.state.il.us or contact the Department’s Taxpayer
Information Division at (217) 782-3336.

Sincerely,

Brian L. Stocker
Staff Attorney (Income Tax)