Are retroactive 'catch-up' retiree healthcare subsidy payments from a City's Illinois Pension Code annuity and benefit funds exempt from Illinois income tax?

Subject

Subtractions

Plain-English summary

This is a General Information Letter (GIL), which the Illinois Department of Revenue itself describes as "designed to provide general information," not a statement of Department policy, and not binding on the Department (86 Ill. Adm. Code 1200.120(b), (c)).

An attorney wrote in on behalf of a taxpayer and over XXX annuitants of a City's four annuity and benefit funds (created under Articles 5, 6, 8, and 11 of the Illinois Pension Code) asking the Department to confirm that retiree healthcare subsidy payments -- including retroactive "bring current" payments covering a past period after the City had stopped paying them during litigation -- are exempt from Illinois income tax. The four funds were already treating the subsidies two different ways: (1) when the fund itself paid the premium by deducting it from the annuitant's benefit, the amount was not reported as federal or Illinois taxable income; but (2) when an annuitant instead bought insurance through another plan and the fund reimbursed them, the fund issued a Form 1099 showing it as income, which would be taxed in Illinois unless the person knew to claim a deduction.

The Department agreed with the attorney's position. It explained that Section 203(a)(2)(F) of the Illinois Income Tax Act (35 ILCS 5/203(a)(2)(F)) lets a taxpayer subtract from Illinois base income any amount included in federal adjusted gross income (AGI) as a distribution "under the provisions of any retirement or disability plan for employees of any governmental agency or unit." Because the four City annuity and benefit funds were created under the Illinois Pension Code, they qualify as such a plan. So if a distribution from one of the funds -- including a retroactive healthcare subsidy "bring current" payment -- is included in the annuitant's federal AGI, it is eligible for the Section 203(a)(2)(F) subtraction. The Department did add one caveat: if the same distribution also qualifies for the separate subtraction in Section 203(a)(2)(I) (recovery of amounts previously deducted from AGI), Section 203(g) bars deducting the same item twice -- the taxpayer must pick one subtraction, not both.

What this means for you

Public-sector retirees and annuitants

If you receive payments from a City or other governmental annuity and benefit fund created under the Illinois Pension Code -- including retroactive "catch-up" healthcare subsidy payments for a period the fund had stopped paying -- those payments can qualify for the Section 203(a)(2)(F) subtraction on your Illinois return, as long as they were included in your federal AGI. This matters most if your fund reimbursed you directly (rather than deducting the premium from your annuity) and issued you a Form 1099 showing the payment as income: you may need to affirmatively claim the subtraction yourself rather than assume it's automatically excluded.

Pension and benefit fund administrators

The GIL confirms that annuity and benefit funds under Illinois Pension Code Articles 5, 6, 8, and 11 count as a "retirement or disability plan for employees of any governmental agency or unit" for purposes of the Section 203(a)(2)(F) subtraction, regardless of the payment mechanism -- "whether paid by annuity reduction, or check, direct deposit, or any other payment form," per the taxpayer's own letter, which the Department did not dispute. If your fund reports subsidy reimbursements on a 1099 rather than folding them into the untaxed annuity deduction, consider flagging to annuitants that they may be entitled to the subtraction.

Accountants and tax preparers

Watch for the anti-double-dipping rule in Section 203(g): a distribution that could be subtracted either under Section 203(a)(2)(F) (governmental retirement/disability plan distributions) or Section 203(a)(2)(I) (recovery of items previously deducted from AGI) can only be subtracted once, not under both provisions. Also remember this is a GIL, not a Private Letter Ruling -- it is not binding on the Department, and a taxpayer who wants a binding answer must request a PLR under the procedure in Section 1200.110(b).

Common questions

Q: Are retroactive "bring current" healthcare subsidy payments from a pension fund taxable in Illinois?
A: Not if they qualify for the Section 203(a)(2)(F) subtraction. The Department confirmed that distributions from Illinois Pension Code annuity and benefit funds -- including retroactive catch-up payments -- are eligible for the subtraction as long as the amount was included in the recipient's federal adjusted gross income.

Q: Does it matter whether the subsidy is paid by deducting it from the annuity versus reimbursing the annuitant directly with a 1099?
A: The underlying tax treatment doesn't change based on payment method, according to the ruling -- but the practical reporting differs. Fund-paid premiums (deducted from the annuity) generally aren't reported as income at all. Reimbursements issued on a 1099 are reported as income, so the recipient may need to actively claim the Section 203(a)(2)(F) subtraction on their Illinois return to avoid being taxed on it.

Q: Can the same payment be deducted under more than one subtraction provision?
A: No. Section 203(g) of the Illinois Income Tax Act states that "nothing in this Section shall permit the same item to be deducted more than once." If a distribution qualifies under both Section 203(a)(2)(F) and Section 203(a)(2)(I), it can only be subtracted once.

Q: Is this ruling binding on the Illinois Department of Revenue?
A: No. This is a General Information Letter, which by the Department's own description "is not a statement of Department policy and is not binding on the Department" (86 Ill. Adm. Code 1200.120(b), (c)). A taxpayer who wants a binding answer for their specific facts must request a Private Letter Ruling.

Q: Which funds were involved in this letter?
A: The letter concerned four annuity and benefit funds created under Articles 5, 6, 8, and 11 of the Illinois Pension Code (40 ILCS 5 et seq.), covering retirees of an unnamed city, though the ruling's reasoning applies generally to distributions from any governmental retirement or disability plan under Section 203(a)(2)(F).

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2021.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2021/it21-0010-gil.pdf

Original ruling text

IT-21-0010 11/23/2021 SUBTRACTIONS
Annuity and benefit funds created under the Illinois Pension Code are
eligible for subtraction modification under Section 203(a)(2)(F) because
the funds constitute “retirement or disability plan(s) for employees of any
governmental agency or unit.”
November 23, 2021
Re: Illinois income tax
Dear NAME:
This is in response to your letter received October 27, 2020, in which you request
additional 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 write as attorney for TAXPAYER. (representative taxpayer) and
over XXX annuitants of the City of CITY’S four annuity and benefit funds,
Illinois Pension Code Articles 5,6, 8 and 11, for confirmation of the income
tax exemption for healthcare subsidy payments, to annuitants under the
1983 and 1985 retiree healthcare statutes, and regardless whether for
current or retrospective payments for past years.
In litigation for annuitants versus the City of CITY and the trustees
of the four annuity and benefit funds, the Funds have been and will be
making distribution of the statutory healthcare subsidies for the periods
YEAR1-YEAR2 ,and going forward in current years, which the Funds had
stopped paying, when the City terminated its retiree health plans.
There is uncertainty voiced as to whether the "bring current"
distributions for the YEAR1-YEAR2 periods are exempt from Illinois
income tax. All four Funds declare that they are treating these payments
as follows:

1. Distributions to annuitants who participate in plans whose
   premiums are paid by their Funds (where the premium is "paid"
   by a deduction or charge against the person's annuity) will not
   be reported as federally taxed income; and so will not be
   included in the person's federal adjusted gross income, nor as
   part of the person's Illinois taxable income.

2. However, persons who, purchased health insurance through
other plans, will receive the statutory subsidy, but will instead be
issued a federal form I099 or (not a form 1099-R) showing the
distribution as income. Accordingly, those statements will result
in the person being taxed under Illinois Income tax, unless the
person knows to claim a deduction on their Illinois tax return.
While we know of no actual adverse authority, it seems clear to us
that such distributions from an Illinois Pension Code annuity & benefit fund
are exempt from Illinois income tax (35 ILCS 5/203(a)(2)(F)), regardless
how it is paid to an annuitant, whether paid by annuity reduction, or check,
direct deposit, or any other payment form.
We request this ruling because the four City of CITY Annuity and
Benefit Funds refuse to report the direct subsidy payments or
reimbursements as retirement payments exempt from Illinois income tax.
RULING
Section 203(a)(2)(F) of the Illinois Income Tax Act (“IITA”, 35 ILCS
5/203(a)(2)(F)) provides the following deduction in the computation of an
individual’s Illinois
base income:
An amount equal to all amounts included in such total pursuant to the
provisions of Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), and
408 of the Internal Revenue Code, or included in such total as
distributions under the provisions of any retirement or disability plan for
employees of any governmental agency or unit, or retirement payments to
retired partners, which payments are excluded in computing net earnings
from self employment by Section 1402 of the Internal Revenue Code and
regulations adopted pursuant thereto. (Emphasis added)
Section 203(a)(2)(I) of the IITA provides the following deduction in the
computation of an individual’s Illinois base income:
An amount equal to all amounts included in such total pursuant to the
provisions of Section 111 of the Internal Revenue Code as a recovery of
items previously deducted from adjusted gross income in the computation
of taxable income;
Section 203(g) of the IITA states as follows:
Unless specifically provided otherwise, nothing in this Section shall permit
the same item to be deducted more than once.

2

Your letter states that the distributions at issue will be made from four annuity
and benefit funds authorized pursuant to Articles 5, 6, 8 and 11 of the Illinois
Penson Code (40 ILCS 5 et seq.). If the distributions from the four funds are
included in the taxpayers’ federal adjusted gross income (“AGI”) than they are
eligible for the subtraction modification under Section 203(a)(2)(F) because the
funds constitute “retirement or disability plan(s) for employees of any
governmental agency or unit.” Please be aware, however, that if a distribution
also qualifies for the subtraction modification found in Section 203(a)(2)(I) for the
recovery of items previously deducted from AGI, than according to Section
203(g) of the IITA, the distribution may not be deducted under both Sections
203(a)(2)(F) and (I).
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) 7822844.
Sincerely,
Michael D. Mankowski
Associate Counsel - Income Tax
cc:

Daily File
Correspondence file:

3