Illinois DOR Amends Income Tax Regulations

Near the end of 2000, the Illinois Department of Revenue (DOR) promulgated and proposed several significant amendments to its income tax regulations. These amendments include changes to the net operating loss (NOL) carryback and carryover provisions and several amendments to the composite-return-filing methodology for passthrough investors, including provisions that allow resident partners and shareholders to join in filing a composite return. In November 2000, the DOR issued long-awaited amendments to its regulations defining "financial organizations" for income tax apportionment purposes.

NOL Carryback and Carryover Changes

Effective Dec. 11, 2000, the Illinois DOR amended 86 Ill. Admin. Code Section 100.2330 on NOL carryforwards and carrybacks. This amendment also provides guidance for Federal law changes. According to the amended regulations, an Illinois NOL that occurred in a tax year ending after Dec. 30, 1999 may be carried back to the two preceding tax years or carried forward to the 20 succeeding tax years. For Illinois NOLs incurred in tax years beginning after Aug. 5, 1997 and ending prior to 2000, special carryover provisions allowed under Sec. 172(b) also apply.

The amendments also clarify the S corporation loss carryover provisions under Illinois Income Tax Act (IITA) Section 207. The DOR explains with its amendments that a loss incurred in a tax year in which a corporation is an S corporation may be carried to a tax year in which it is no longer an S corporation (i.e., in the same manner as if the corporation were an S corporation for the whole year). Likewise, a C loss may be carried over to and deducted in any tax year in which it is an S corporation.

Composite-Filing-Return Provisions

The DOR amended 86 Ill. Admin. Code Section 100.5130, effective Dec. 11, 2000, to update the provisions for filing composite returns by partnerships and S corporations on behalf of their partners and shareholders. The previous regulation was modified to update the listing of addition and subtraction modifications allowed to partnerships and S corporations in computing their personal property tax replacement income tax liabilities, but not to their partners and shareholders in computing the tax due on composite returns. The regulation was also amended to add statutory references for the addition and subtraction modifications, and to eliminate specific line references for the modifications, so that the regulation will not require future amendments if the forms are changed. Finally, the regulations were amended to expressly provide that Illinois resident partners and shareholders can join in the filing of composite returns. Prior to this amendment, an S corporation was required to obtain advance approval from the DOR before including a resident shareholder in its composite return. Such approval was not readily granted by the DOR, unless it appeared to be the only way to ensure compliance.

Long-Awaited "Financial Organization" Reg.

The Illinois DOR has finally issued a proposed regulation that defines the term "financial organization" for Illinois income tax apportionment purposes (Proposed 86 Ill. Admin. Code Section 100.9710, published at 24 Ill. Reg. 16957, Nov. 17, 2000).

Historically, the IITA has required a special single-factor apportionment formula for financial organizations. Moreover, since 1982, it has not allowed them to be included in the same unitary business group with taxpayers required to use a different apportionment (i.e., three-factor) formula. The IITA Section 1501(a)(8) definition of "financial organization" is problematic; it lists 17 types of entities but only defines "bank" and "sales finance company," leaving the other 15 subject to interpretation.

The proposed regulation seeks to solve this problem by providing a detailed description of the "characteristic services" of each type of entity. It also sets forth tests that must be met for an entity to qualify as a financial organization. Finally, the proposed rule provides that the 17 entities listed in the statute (and described in the rule) constitute an exclusive and exhaustive list of the types of entities that qualify as financial organizations.

One important test established by the proposed regulation is a "gross income test." Under IITA Section 100.9710(b), an entity must be "predominantly engaged" (i.e., greater than 80%, averaged over a three-year period) in the business activities of a financial organization during the year to qualify. However, banks, bank holding companies and persons owned by banks or bank holding companies do not have to meet the gross income test to qualify; sales finance companies have only a 50% gross-income test. Moreover, under the proposed regulation, an entity's transactions with an affiliate are treated as if they had been conducted with an unrelated party. Thus, transactions eliminated in unitary combination under IITA Section 100.3320(d) are still considered in calculating the gross income test under Section 100.9710(b)(6).

It is expected that this proposed rule will proceed through the formal rulemaking process without significant changes.

From Glenn C. McCoy, Jr., J.D., and Karin M. Ecroyd, MST, New York, NY