Does a private equity fund member or its management company have Illinois income tax nexus, and how is income from selling LLC units or receiving management fees apportioned to Illinois?

Plain-English summary

This General Information Letter responds to a taxpayer researching private equity fund structures in Illinois. The taxpayer asked two questions: (1) whether nonresident members who sell units (not assets) of an LLC operating in Illinois must apportion gain or loss and face Illinois withholding, and (2) whether a management company that collects fees from a private equity fund — with some Illinois-resident limited partners but no physical presence in Illinois — has nexus with Illinois under the state's market-based sourcing rules.

The Illinois Department of Revenue declined to answer the nexus question directly, stating that "the determination as to whether a taxpayer has nexus with Illinois is extremely fact-specific" and that the Department does not issue rulings on nexus. It directed the taxpayer to 86 Ill. Adm. Code 100.9720 for general nexus guidance.

Instead of a nexus ruling, the Department laid out the general Illinois Income Tax Act (IITA) framework for how income would be sourced if a taxpayer is subject to Illinois tax: nonresidents compute Illinois net income based on the portion of their base income apportioned or allocated to Illinois under Article 3 of the IITA. Gains from intangible property (such as LLC units) are sourced to Illinois based on where the income-producing activity occurs, using a performance-costs test. Sales of services are sourced to where the customer receives the service (market-based sourcing), generally the customer's fixed place of business. Nonbusiness income allocation and nonresident partner withholding under IITA Section 709.5 are also summarized.

Because this is a GIL, it does not resolve whether nexus actually exists for either the fund members or the management company in the taxpayer's specific facts — it only explains the mechanical apportionment and sourcing rules that would apply once nexus and taxability are established.

What this means for you

If you are a nonresident member selling LLC units

Under IITA Section 304(a)(3)(C-5)(iii), gain from the sale of intangible personal property (like LLC membership units, as opposed to the LLC's underlying assets) is sourced to Illinois based on where the income-producing activity is performed — not automatically based on where the LLC operates. If you are not a dealer in such property, the gain is Illinois-source only if the income-producing activity is performed in Illinois, or predominantly in Illinois compared to other states, based on performance costs. Whether you have nexus (and thus owe tax or face withholding) depends on the specific facts, which the Department will not rule on in a GIL.

If you operate a management company receiving fees

Under IITA Section 304(a)(3)(C-5)(iv), service fee income is sourced to where the customer (here, the fund or its partnership) receives the service — generally the customer's fixed place of business, or the office from which the service was ordered or billed if that is not determinable. Having Illinois-resident limited partners in the fund does not, by itself, establish nexus for a service provider with no physical presence in Illinois; sourcing under market-based rules is a separate question from nexus, and the Department expressly would not rule on whether nexus exists here.

If you are a partnership with nonresident partners

IITA Section 305 requires a nonresident partner to include in Illinois net income their distributive share of the partnership's business income apportioned to Illinois, plus their share of nonbusiness income allocated to Illinois. IITA Section 709.5 then requires the partnership to withhold tax on that nonresident partner's apportioned and allocated share, subject to exceptions such as amounts allocated to the partner's own commercial domicile.

Common questions

Does this letter say whether the fund members or management company have Illinois nexus?
No. The Department explicitly refused to rule on nexus, calling it "extremely fact-specific," and instead pointed to 86 Ill. Adm. Code 100.9720 for general guidance.

How is gain from selling LLC units sourced under Illinois law?
Under IITA Section 304(a)(3)(C-5)(iii), for a non-dealer, the gain is Illinois-source if the income-producing activity is performed in Illinois, or is performed predominantly in Illinois relative to other states, measured by performance costs.

How are the management company's service fees sourced?
Under IITA Section 304(a)(3)(C-5)(iv), sales of services are sourced to where the customer receives the service, generally the customer's fixed place of business; if that cannot be determined, the office from which the service was ordered, or failing that, the billing office, is used.

Can I get a binding answer instead of this general letter?
Yes — the letter notes that if you are not under audit, you may request a binding Private Letter Ruling by submitting the information required in items 1 through 8 of 86 Ill. Adm. Code Section 1200.110(b).

Citations and references

• 86 Ill. Adm. Code 1200.120(b) and (c) — General Information Letters are not binding Department policy
• 86 Ill. Adm. Code 100.9720 — general nexus guidance
• 35 ILCS 5/201 (IITA Section 201) — nonresident liability for Illinois income tax
• 35 ILCS 5/202 (IITA Section 202) — definition of Illinois net income
• 35 ILCS 5/203 (IITA Section 203) — definition of base income
• 35 ILCS 5/301(c)(2) (IITA Section 301(c)(2)) — allocation of income not otherwise specifically allocated
• 35 ILCS 5/303 (IITA Section 303) — allocation rules for specific items of nonbusiness income
• 35 ILCS 5/304(a)(3)(C-5)(iii) (IITA Section 304) — sourcing of intangible property income to the apportionment numerator
• 35 ILCS 5/304(a)(3)(C-5)(iv) (IITA Section 304) — sourcing of service sales to the apportionment numerator
• 35 ILCS 5/305 (IITA Section 305) — allocation/apportionment rules for nonresident partners
• 35 ILCS 5/305(c-5) (IITA Section 305(c-5)) — special rules for investment partnerships
• 35 ILCS 5/709.5 (IITA Section 709.5) — partnership withholding on nonresident partners
• 35 ILCS 5/1501(a)(11.5) (IITA Section 1501(a)(11.5)) — definition of investment partnership
• 86 Ill. Adm. Code 1200.110(b) — requirements for requesting a binding Private Letter Ruling

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2017.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2017/it-17-0001-gil.pdf

Original ruling text

IT 17-0001-GIL 01/09/2017 NEXUS
Whether taxpayer has nexus with Illinois is extremely fact-specific. Department does not
issue rulings regarding nexus with the State

January 9, 2017
Re:

Illinois income tax

Dear Xxxxx:
This is in response to your letter received November 22, 2016, in which you request 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:
I am doing some research regarding private equity funds in the state of Illinois and would
like to receive some reference regarding this topic.
1) When members of a private equity fund have ownership in a flow thru investment and
then they ultimately decide to sell some of the units (not assets) of the LLC that have
operations in the state of Illinois. Do the sellers need to apportion some of the gain/loss
and therefore incur withholding in the state of Illinois even if they are not residents of the
state of Illinois and their only connection to Illinois is their investment in this flow thru entity.
2) When a private equity fund pays fees to a management company and some of the
members of the Limited Partnership are residents of the State of Illinois. Will the
management company be subject to Nexus rules since they are only a service organization
and have no physical presence in Illinois but will be subject to income tax since the state
of Illinois follows market based rules or will they not be subject to income tax in the state
of Illinois.
If you can please provide the reference or citations of these laws as well as your ID number
that would be much appreciated.

RULING
The determination as to whether a taxpayer has nexus with Illinois is extremely fact-specific.
Therefore, the Department does not issue rulings regarding whether a taxpayer has nexus with
the State. For information regarding nexus, see Department of Revenue Regulations Section
100.9720 (accessible from the Department’s web site). In addition, the following general
information may be provided.
A nonresident is liable for Illinois income tax under Section 201 of the Illinois Income Tax Act
(“IITA” 35 ILCS 5/201) if it computes “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.
Under Article 3 of the IITA, business income is apportioned to Illinois based on an apportionment
ratio in which the numerator is the amount of the taxpayer’s sales in Illinois and the denominator
is the amount of the taxpayer’s sales everywhere. IITA Section 304(a)(3)(C-5)(iii) allocates income
from intangible property (other than patents, copyrights, trademarks, and similar items) to the
numerator of the apportionment formula as follows:
In the case of interest, net gains (but not less than zero) and other items of income from
intangible personal property, the sale is in this State if:
(a) in the case of a taxpayer who is a dealer in the item of intangible personal property
within the meaning of Section 475 of the Internal Revenue Code, the income or gain is
received from a customer in this State. For purposes of this subparagraph, a customer
is in this State if the customer is an individual, trust or estate who is a resident of this
State and, for all other customers, if the customer’s commercial domicile is in this State.
Unless the dealer has actual knowledge of the residence or commercial domicile of a
customer during the taxable year, the customer shall be deemed to be a customer in
this State if the billing address of the customer, as shown in the records of the dealer,
is in this State; or
(b) in all other cases, if the income-producing activity of the taxpayer is performed in this
State or, if the income-producing activity of the taxpayer is performed both within and
without this State; if a greater proportion of the income-producing activity of the taxpayer
is performed within this State than in any other state, based on performance costs.

IITA Section 304(a)(3)(C-5)(iv) allocates sales of services to the numerator of the apportionment
formula as follows:
Sales of services are in this State if the services are received in this State. For the purposes
of this section, gross receipts from the performance of services provided to a corporation,
partnership, or trust may only be attributed to a state where that corporation, partnership,
or trust has a fixed place of business. If the state where the services are received is not
readily determinable or is a state where the corporation, partnership, or trust receiving the
service does not have a fixed place of business, the services shall be deemed to be
received at the office of the customer from which the services were ordered in the regular
course of the customer’s trade or business. If the ordering office cannot be determined, the
services shall be deemed to be received at the office of the customer to which the services
are billed. If the taxpayer is not taxable in the state in which the services are received, the
sale must be excluded from both the numerator and denominator of the sales factor. The
Department shall adopt rules prescribing where specific types of service are received,
including, but not limited to publishing, and utility service.
The nonbusiness income of a nonresident is allocated to Illinois pursuant to the provisions of IITA
Sections 301(c)(2) and 303. IITA Section 301(c)(2) provides that any item of income or deduction
that is not specifically allocated or apportioned pursuant to IITA Sections 302, 303 or 304, in the
case of an individual, trust, or estate, shall not be allocated to Illinois; and in the case of a
corporation or partnership, shall be allocated to Illinois only if the taxpayer had its commercial
domicile in Illinois. IITA Section 303 provides allocation rules for the specific items of income set
forth in that section. In the case of capital gain or loss from the sale or exchange of intangible

personal property, such gain or loss is allocated to Illinois only if the taxpayer’s commercial
domicile is Illinois.
IITA Section 305 provides special allocation and apportionment rules in the case of a nonresident
partner with respect to the partner’s distributive share of income of a partnership. Under IITA
Section 305(a), a nonresident partner must include in Illinois net income the partner’s distributive
share of the business income of the partnership that is apportioned to Illinois in the hands of the
partnership. Under IITA Section 305(b), a nonresident partner allocates to Illinois the partner’s
share of the nonbusiness income of the partnership as if such income was received directly by
the partner. IITA Section 305(c) states that a partnership shall allocate and apportion its base
income to Illinois under Article 3 in the same manner as any other nonresident. IITA Section 305(c5) provides special rules for the allocation or apportionment of a nonresident partner’s distributive
share of the income of an investment partnership (as defined in IITA Section 1501(a)(11.5).
IITA Section 709.5 requires a partnership to withhold partner-level tax with respect to a
nonresident partner’s distributive share. In general, a partnership must withhold tax on a
nonresident partner’s distributive share of the business income of the partnership apportioned to
Illinois plus the nonresident partner’s share of the nonbusiness income of the partnership
allocated to Illinois under IITA Section 303 (other than an amount allocated to the commercial
domicile of the taxpayer under IITA Section 303).
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) 782-2844.
Sincerely,

Brian L. Stocker
Associate Counsel (Income Tax)