Under Illinois Income Tax Act Section 304(a)(3)(C-5)(iii)(a), is a company that originates loans to customers a 'dealer' for sales-factor sourcing purposes even though it qualifies for the federal 'negligible sales' exemption from mark-to-market accounting?

Plain-English summary

The Illinois Department of Revenue ruled that a Delaware limited partnership originating senior secured loans to North American middle-market companies is a "dealer in securities" for purposes of sourcing interest income into the Illinois sales factor, even though the taxpayer is exempt from the federal mark-to-market accounting method that normally applies to securities dealers.

The taxpayer's business model was straightforward: it made senior secured loans directly to companies with less than $25 million in EBITDA, generating interest income that is ordinary income for federal tax purposes. Under Internal Revenue Code Section 475(c)(1), regularly originating loans to customers in the ordinary course of business meets the definition of a "dealer in securities." Normally that status forces mark-to-market accounting under IRC Section 475(a). But Treas. Reg. 1.475(c)-1(c)(1) carves out an exception: a taxpayer that regularly originates loans but makes no more than "negligible sales" of those loans is not treated as a dealer for mark-to-market purposes -- unless it affirmatively elects dealer treatment. The taxpayer here qualified for that negligible-sales exemption and had not elected out of it, and asked whether it was still a "dealer" for Illinois apportionment purposes.

The Department held that the Illinois sourcing rule in 35 ILCS 5/304(a)(3)(C-5)(iii) does not turn on whether a taxpayer elects out of the federal mark-to-market exemption. In either case, the taxpayer earns interest by making loans to customers in the ordinary course of its trade or business, and that activity independently satisfies the IRC Section 475 dealer definition. So the taxpayer is a dealer for Illinois sales-factor purposes, meaning its interest income from loans must be sourced to Illinois in the numerator of the sales factor when the customer is an Illinois resident or has an Illinois commercial domicile (determined, absent actual knowledge, by the customer's billing address on file), rather than sourced based on where the taxpayer's income-producing activity occurs.

This is a dealer-classification and sourcing ruling, not a ruling that changes the amount of tax owed -- it simply tells the taxpayer which of the two sourcing rules in Section 304(a)(3)(C-5)(iii) (the "dealer" rule in subpart (a), based on customer location, versus the "non-dealer" rule in subpart (b), based on where income-producing activity occurs) applies to its interest income.

What this means for you

Loan originators and specialty lenders

If your business regularly originates loans to customers in the ordinary course of business -- even if you qualify for the federal "negligible sales" exemption from mark-to-market accounting and haven't elected out of it -- this ruling indicates the Illinois Department of Revenue will still treat you as a "dealer in securities" for Illinois sales-factor sourcing. That means your interest income from those loans is sourced to Illinois based on the customer's residence or commercial domicile (or billing address, absent actual knowledge), not based on where your income-producing activity takes place.

Accountants and tax professionals

The ruling clarifies that the federal mark-to-market election (or non-election) under Treas. Reg. 1.475(c)-1(c)(1) is not determinative for Illinois apportionment purposes under 35 ILCS 5/304(a)(3)(C-5)(iii). A taxpayer that meets the IRC Section 475(c)(1) dealer definition through regular loan origination is a dealer for Illinois sourcing regardless of whether it uses mark-to-market accounting federally. When apportioning interest income for a client in this fact pattern, confirm customer billing addresses and residence/commercial-domicile data, since that drives Illinois sourcing under the dealer rule.

Fund managers and asset managers structured as partnerships

The taxpayer here was a Delaware limited partnership managed by an SEC-registered investment adviser, generating interest income reported as ordinary income on its Form 1065. If your fund has a similar structure -- originating loans as a core business activity across multiple states, including Illinois -- this ruling signals how the Department analyzes dealer status for apportionment even where federal tax accounting treatment differs from state sourcing treatment.

Common questions

Q: Can I rely on this ruling for my own business?
A: No, not directly. This is a Private Letter Ruling under 2 Ill. Adm. Code 1200.110, binding on the Department only as to the taxpayer who requested it, and only to the extent the facts that taxpayer gave were correct and complete. No other taxpayer can rely on it, even in a similar fact pattern. It can still be useful as an illustration of the Department's reasoning.

Q: Why does it matter whether the taxpayer is a "dealer" under IRC Section 475?
A: Under 35 ILCS 5/304(a)(3)(C-5)(iii), the sourcing rule for interest and other income from intangible personal property depends on dealer status. Dealers source that income to Illinois based on where the customer is located (resident, commercial domicile, or billing address). Non-dealers source it based on where the taxpayer's income-producing activity is performed. The two rules can produce very different sales-factor numerators.

Q: Does qualifying for the federal "negligible sales" exemption mean a loan originator escapes dealer status for Illinois purposes?
A: According to this ruling, no. The Department concluded that the Illinois sourcing rule should not depend on whether a taxpayer elects out of the Treas. Reg. 1.475(c)-1(c)(1) exemption from mark-to-market accounting. Regularly originating loans to customers in the ordinary course of business independently satisfies the dealer definition in IRC Section 475(c)(1), so the taxpayer is treated as a dealer for Illinois sales-factor sourcing either way.

Q: How is the customer's location determined under the dealer sourcing rule?
A: Per 35 ILCS 5/304(a)(3)(C-5)(iii)(a), a customer is in Illinois if the customer is an individual, trust, or estate resident in Illinois, or, for other customers, if the customer's commercial domicile is in Illinois. Unless the dealer has actual knowledge of the customer's residence or commercial domicile during the taxable year, the customer is deemed to be in Illinois if the billing address shown in the dealer's records is in Illinois.

Citations and references

Statutes and regulations:

• 35 ILCS 5/304(a)(3)(A) -- general definition of the Illinois sales factor
• 35 ILCS 5/304(a)(3)(C-5)(iii) -- sourcing rule for interest, net gains, and other income from intangible personal property, including the dealer vs. non-dealer distinction
• 2 Ill. Adm. Code 1200.110 -- private letter ruling procedure, including binding effect limited to the requesting taxpayer
• 26 U.S.C. § 475(c)(1) -- federal definition of "dealer in securities"
• 26 U.S.C. § 475(a)-(b) -- mark-to-market accounting method and exceptions for dealers
• Treas. Reg. § 1.475(c)-1(c)(1) -- exemption from dealer status for taxpayers with no more than negligible sales of originated loans

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2018.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2018/it-18-0008-plr.pdf

Original ruling text

IT 18-0008-PLR 11/29/2018 2018 SALES FACTOR -INTANGIBLE PROPERTY
Taxpayer originating loans to customers in ordinary course of business is Dealer

November 29, 2018
Re:

Request for Private Letter Ruling
TAXPAYER
FEIN: ####

Dear Xxxxx:
This is in response to your letter dated June 12, 2018 in which you request a Private Letter Ruling
on behalf of TAXPAYER. Review of your request for a Private Letter Ruling indicates that all
information described in paragraphs 1 through 8 of subsection (b) of 2 Ill. Adm. Code 1200.110 is
contained in your request. This Private Letter Ruling will bind the Department only with respect to
TAXPAYER. Issuance of this ruling is conditioned upon the understanding that TAXPAYER and/or
any related taxpayer(s) is not currently under audit or involved in litigation concerning the issues that
are the subject of this ruling request.
The facts and analysis as you have presented states as follows:
On behalf of our client, TAXPAYER (FEIN: 82-1737205), hereinafter referred to as
“Taxpayer”), we respectfully request the issuance of a private letter ruling (“PLR”) by the
Illinois Department of Revenue (“Department”) pursuant to 2 Ill Adm. Code 1200.110.
General Information

1. This PLR is not requested for hypothetical or alternatively proposed transactions; but rather
   to determine the income tax consequences of an actual transaction engaged in by Taxpayer,
   as described below.
2. Taxpayer is not currently engaged in litigation with the Department with regard to this or
   any other tax matter.
3. The Department has not previously ruled regarding this matter for Taxpayer. Neither
   Taxpayer nor TAX PRACTITIONER has submitted the same or similar issue to the
   Department on behalf of Taxpayer.
4. We are aware of no authority contrary to the authorities referred to and cited below.
   Statement of Facts
   Taxpayer is a Delaware limited partnership established to provide partners with current
   income and long-term capital appreciation. This is achieved primarily by originating senior
   secured loans directly to North American middle market companies. The taxpayer serves as

IT 18-0008-PLR
Page 2
a senior secured lender primarily to U.S. companies with less than $25 million EBITDA which
require financing to fund corporate events such as a buyout, recapitalization, ownership
transfer, sourcing of expansion and capital growth or refinancing.
Taxpayer is managed by COMPANY (hereinafter “COMPANY”). Through COMPANY’s
management, the taxpayer has access to an asset management and origination platform,
which includes a national transaction sourcing network. It is noteworthy that while the taxpayer
is not directly subject to regulation as an investment company, COMPANY is subject to
regulation by the United States Securities and Exchange Commission as a Registered
Investment Advisor.
Taxpayer is actively engaged in the business of originating and investing in senior secured
loans and is treated as such for federal income tax purposes. Accordingly, under the Internal
Revenue Code interest income earned by the taxpayer is treated as ordinary income and
included on its Form 1065. Taxpayer generates interest income in Illinois and other states
from loans secured by assets located across the United States.
By statute, Taxpayer would be considered a dealer in securities for federal income tax
purposes. However, the taxpayer qualifies for an exemption under Treas. Reg. 1.475(c)-1(c).
This regulation provides a taxpayer with an exception from using the mark-to-market method
of accounting. Taxpayer is trying to determine if it would still be considered a dealer for Illinois
Income Tax purposes, and thus, allowed to apportion its income under Illinois Income Tax
Act 304(a)(3)(C-5)(iii)(a).
Requested Rulings
Though Taxpayer is not a dealer for federal income tax purposes because of the regulatory
exemption under Treas. Reg. 1.475(c)-1(c), Taxpayer is otherwise a dealer as defined by 26
USC 475 and thus is considered a dealer for purposes of Illinois Income Tax Act 304(a)(3)(C5)(iii)(a)?
Analysis
Illinois has various methods of sourcing interest income; the sourcing depends upon whether
the taxpayer is classified as a dealer within the meaning of 26 USC 475. If the taxpayer is not
a dealer, interest income is sourced to Illinois if the taxpayer’s income-producing activity is
performed in Illinois. However, if the taxpayer is a dealer, 35 ILCS 5/304(a)(3)(C-5)(iii)(a)
states:
“in the case of a taxpayer who is a dealer in the item of intangible 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.”

IT 18-0008-PLR
Page 3
In looking to federal tax law, Section 475(c)(1) of the Internal Revenue Code (“Code”) defines
a “dealer in securities” as a taxpayer who:
(A)
(B)

regularly purchases securities from or sells securities to customers in the
ordinary course of a trade or business; or
regularly offers to enter into, assume, offset, assign, or otherwise terminate
positions in securities with customers in the ordinary course of a trade or
business.

In the ordinary course of business, Taxpayer originates loans directly with customers, that is,
Taxpayer makes loans by advancing cash in exchange for debt obligations of its customers.
As Taxpayer regularly originates loans to customers, Taxpayer meets the definition of a
“dealer in securities” as defined in the Code.
In general, Section 475 of the Code requires a dealer in securities to use a mark-to-market
method of accounting. By regulatory grace, however, the IRS effectively provides a taxpayer
with an exception (by not viewing the taxpayer as a dealer) from this mark-to-market
accounting if the taxpayer does not engage in more than “negligible sales” of securities it has
originated to customers. (Treas. Reg. 1.475-1(c)(1)(i)).
A taxpayer with “negligible sales” nonetheless may elect out of this regulatory exemption by
filing its return using the mark-to-market method of accounting described in Section 475(a).
(Treas. Reg. 1.475(c)-1(c)(1)(ii))
In summary, Taxpayer meets the definition of a “dealer in securities” as defined by the Code.
Taxpayer, however, qualifies for a regulatory exemption not to use the mark-to-market method
of accounting. Since taxpayer would technically meet the dealer definition under 475(c) but
for the exemption, the rule allows them to elect dealer status if they want it. As a result, it
would appear Taxpayer could still be considered a dealer for Illinois income tax purposes.
Conclusion
If the Taxpayer is not a dealer because they qualify for the exemption under Treas. Reg.
1.475(c)-1(c), the taxpayer would still be considered a dealer for purposes of IITA 304(a)(3)(C5)(iii)(a).
We respectfully request a private letter ruling from the Department regarding this matter.
Should you disagree with this opinion, please contact me to discuss this opinion prior to
issuing a ruling. If you have any further questions or require any additional information, please
contact me.

RULING
Section 304(a)(3)(A) of the Illinois Income Tax Act (“IITA” ; 35 ILCS 5/304(a)(3)(A)) defines the sales
factor for taxpayers other than insurance companies, financial organizations, federally regulated
exchanges, and transportation companies, as follows:

IT 18-0008-PLR
Page 4
The sales factor is a fraction, the numerator of which is the total sales of the person in this
State during the taxable year, and the denominator of which is the total sales of the person
everywhere during the taxable year.
IITA Section 304(a)(3)(C-5) provides, in part, that, for taxable years ending on or after December 31,
2008, sales, other than sales governed by paragraphs (B), (B-1), (B-2), (B-5) and (B-7), are in this
State if any of the following criteria are met:
(iii) 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 a 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 any other state, based on
performance costs.
Section 475 of the Internal Revenue Code (IRC) prescribes use of the mark-to-market accounting
method for dealers in securities. Section 475(c)(1) defines a “dealer in securities” to mean a taxpayer
who:
(A)
(B)

regularly purchases securities from or sells securities to customers in the
ordinary course of a trade or business; or
regularly offers to enter into, assume, offset, assign or otherwise terminate
positions in securities with customers in the ordinary course of a trade or
business.

Section 475(a) requires that a dealer in securities apply the mark-to-market method of accounting.
Section 475(b) allows for exceptions to mark-to-market accounting for dealers, providing that
subsection (a) shall not apply to certain securities held by a dealer including:
(B)(i) any security described in subsection (c)(2)(C) which is acquired (including originated)
by the taxpayer in the ordinary course of a trade or business of the taxpayer and which is not
held for sale, and (ii) any obligation to acquire a security described in clause (i) if such
obligation is entered into in the ordinary course of such trade or business and is not held for
sale.
Pursuant to these provisions, Treas. Reg. § 1.475(c)-1(c)(1) provides for the following exemption
from dealer status:

IT 18-0008-PLR
Page 5
A taxpayer that regularly purchases securities from customers in the ordinary course of a
trade or business (including regularly making loans to customers in the ordinary course of a
trade or business of making loans) but engages in no more than negligible sales of the
securities so acquired is not a dealer in securities within the meaning of section 475(c)(1)
unless the taxpayer elects to be so treated or, for purposes of section 471, the taxpayer
accounts for any security (as defined in section 475(c)(2)) as inventory.
Under IITA Section 304(a)(3)(C-5)(iii), whether interest, net gains, and other items of income from
intangible personal property are assigned to Illinois for sales factor purposes depends on whether
the taxpayer “is a dealer in the item of intangible personal property within the meaning of Section
475 of the Internal Revenue Code.” If the taxpayer is a dealer within the meaning of IRC Section
475, the gross receipts are assigned to Illinois if the customer is in Illinois. If the taxpayer is not a
dealer within the meaning of IRC Section 475, the gross receipts are assigned to Illinois under
Section 304(a)(3)(C-5)(iii)(b) if the income-producing activity is in Illinois. For this purpose, a taxpayer
is a dealer with respect to an item of intangible personal property if the taxpayer is actually a dealer
with respect to the item under IRC Section 475, or would be a dealer with respect to the item under
IRC Section 475 if the item were a security as defined in IRC Section 475(c)(2).
Your letter represents that the Taxpayer derives interest income by making loans to customers in
the ordinary course of its trade or business. You represent that the Taxpayer is not a dealer in
securities within the meaning of IRC Section 475(c)(1) by virtue of the exemption allowed under
Treas. Reg. § 1.475(c)-1(c)(1) to taxpayers who make only negligible sales of loans that they
originate and who do not elect out of the exemption. The particular sourcing rule under IITA Section
304(a)(3)(C-5)(iii) to be applied should not depend on whether a taxpayer does or does not elect out
of the dealer exemption available under Treas. Reg. 1.475(c)-1(c)(1). In either case, the taxpayer
earns interest by making loans to customers in the ordinary course of its trade or business.
Accordingly, for purposes of IITA Section 304(a)(3)(C-5)(iii), a taxpayer who is eligible for the
exemption under Treas. Reg. 1.475(c)-1(c)(1) is considered a dealer in securities with respect to
loans it originates to customers whether or not the taxpayer elects out of the exemption. In this case,
then, Taxpayer must include the interest income from loans made to its customers in the numerator
of its Illinois sales factor under IITA Section 304(a)(3)(C-5(iii)(a) if the customer is a resident of Illinois
or its commercial domicile is in this State.
This ruling shall bind the Department as provided herein. The facts upon which this ruling is based
are subject to review by the Department during the course of any audit, investigation or hearing and
this ruling shall bind the Department only if the material facts as recited and incorporated in this
ruling are correct and complete. This ruling shall bind the Department for all taxable years, except
as limited pursuant to 2 Ill. Adm. Code 1200.110(d) and (e).This ruling will cease to bind the
Department if there is a pertinent change in statutory law, case law, rules or in the material facts
recited in this ruling.
Sincerely,

Brian L. Stocker
Chairman, PLR Committee (Income Tax)