2004 Practitioners' Questions and Answers
Note: The answers by the Department of Revenue to the questions below are not to be relied upon by taxpayers in lieu of a Private Letter Ruling and are not the kind of written information upon which a taxpayer may rely to request an abatement under the Taxpayer Bill of Rights. Where a conflict appears to exist between these answers and a form, instruction, regulation or bulletin issued by the Department, taxpayers are advised to follow the form, instruction, regulation or bulletin, contact the Department's Business Hotline at (217) 524-4772, or seek a Private Letter Ruling.
Q. Why must refunds of state and local income taxes, other than Illinois, previously deducted on US 1040 schedule A in prior years and included on current year US 1040 page 1 be reported as a subtraction on line 9? Why not change the reporting for IL 1040 line 7?
Response:
This subtraction has been a separate line item since 1986 because we can cross-check it against information we receive from the IRS.
Q. Why not require that Illinois K-1s be filed with the entity's tax return and then eliminate the need to attach it to the taxpayer's return to support subtractions? It would seem possible that a taxpayer could attach a fake IL K-1. Under the current method of filing, the IDOR has no way of knowing if this were true. Currently, the IL-1040 requirement to attach the IL-K-1-P disqualifies the taxpayer from e-filing. Removing the IL-K-1-P attachment requirement for the IL-1040 will help the e-filing program.
Response:
The question applies to partner/partnerships, shareholders/subchapter S corporations and beneficiaries/trusts. For simplicity, the answer will use the terms individual and flow-through entity to cover all of these situations.
The K-1-P, K-1-T or other similar flow-through documentation is required at the individual level because it is needed to support the income, subtractions or credits being claimed at that level. If the information was only included with the flow-through entity's return, the information would have to be cross-referenced in some way to be available to support the individual return items.
Most taxpayers with flow-through entity items, honestly rely upon the information provided by the entity to complete their return. There is always a possibility, however, that a taxpayer may create false flow-through information to support an item on the individual return. The Department has many processes in place that help identify these situations, including audits of the flow-through entities and their related individuals.
You are correct that individual taxpayers who are required to support items with flow-through entity information are currently prohibited from using one of our electronic filing options to file their IL-1040. The Department views this as one of the areas where electronic filing can be expanded in the future as resources become available.
Q. Effective for 2004, for Illinois corporate income tax purposes, interest expense paid to a foreign affiliate is not deductible unless the payment meets the following test:
(i) an item of interest paid, accrued, or incurred, directly or indirectly, to a foreign person who is subject in a foreign country or state, other than a state which requires mandatory unitary reporting, to a tax on or measured by net income with respect to such interest; A similar test exists for intangible expense payments made to foreign affiliates.
What level of documentation will the Illinois Department of Revenue require to support the conclusion that the above test has been met for payments made to an affiliate in a foreign country?
Response:
We would want evidence of the payment of interest and a return filed by the affiliate showing its interest income was taxed by the foreign country or the other state.
Q. The recently enacted Illinois tax shelter reporting requirements were made effective for the first return due after the date of the enactment. Does this mean original due date or extended due date?
Response:
In Draft Regulation Section 100.5060(b)(2), we state that this reference is to the original due date. Thus, a calendar-year taxpayer would be required to file its disclosure for years ending prior to December 31, 2004, with its 2004 return. The draft regulation also provides that a taxpayer may elect to file a disclosure for years ending prior to December 31, 2004, with an earlier return, so that anyone who files its first disclosure with its 2003 return will have satisfied the requirement, and will not need to file the same disclosure again with its 2004 return.
Q
. Illinois Bill H4914 limits the deduction to $10,000 for contributions a College Savings Pool or Illinois Prepaid Tuition Trust for tax years beginning on or after January 1, 2005.
Is the limit $10,000 per contributor or $10,000 per savings account? For, example if a husband and wife each make contributions of $11,000 (annual gift tax exclusion) to each of their three children’s accounts (total $66,000 contributed), how much of a deduction will they have on their jointly filed IL return? Is the deduction limited to $10,000, or $10,000 per taxpayer for a total of $20,000, or per saving account or $30,000 or per taxpayer’s contribution to each account for total of $60,000?
Response:
The allowable subtraction is $10,000 per taxpayer, or $20,000 for a joint return, regardless of how many accounts may be involved.
Q. An equipment leasing company prepared their federal return following the depreciation requirements for bonus depreciation. However, this depreciation amount was limited because of the Passive Activity Loss rules. Under the Passive Activity Loss Limitation rules, Passive Activity Deductions in excess of Passive Activity Income are disallowed as not deductible in the current year (IRC Sec. 469(e)(2)(A)). This limitation applies to individuals and closely held “C” corporations. Therefore, the taxpayer was unable to derive any federal tax benefit from the deduction of the bonus depreciation.
The Illinois Income Tax Act (35 ILCS 5(b)(2)) provides that federal taxable income “shall be modified by adding thereto an amount equal to the bonus depreciation deduction (30% of the adjusted basis of the qualifying property) taken on the taxpayer’s federal income tax return for the taxable year under subsection (k) of Section 168 of the Internal Revenue Code.” Even though bonus depreciation was computed on form 4562, no bonus depreciation was taken in the computation of 1120, line 28, federal Taxable Income. The Passive Activity Loss Limitation disallowance exceeded the amount of the computed bonus depreciation, so that no bonus depreciation was taken in the computation of federal taxable income.
Should a taxpayer, who derived no benefit from bonus depreciation on the Federal return be required to add back the bonus depreciation calculated for the Federal return?
Response:
The taxpayer in this case has received a federal benefit since it is entitled to a loss deduction allowable in later years that was caused, in part, by the bonus depreciation. The fact that they would have had the same taxable income had they elected not to take bonus depreciation does not mean they did not actually take the deduction, nor does it mean they derived no benefit from it. The bonus depreciation has helped offset current gross income and helped produce a loss that can be taken in future years.
In any event, the statute requires all bonus depreciation deductions to be added back in the year claimed, and provides no exception for taxpayers who actually received no benefit.
Q. Where an S corporation has received a Film Production Services Tax Credit, can this credit be applied against a shareholder's personal income tax liability in an amount in excess of the liability attributed to the S corporation's income?
Response:
Yes. If, for example, the S corporation had a net loss, the loss and the credit would both flow through to the shareholders in proportion to their stock ownership. If, however, the question that was intended is, "Can an S corporation pass through to a shareholder an amount of credit that is not proportional to the shareholder's stock ownership?", the answer is, "No." IITA Section 213 allows the credit to flow through as provided by Subchapter S of the IRC, and IRC Section 1366(a)(1) provides for "pro-rata" pass-through of a Subchapter S corporation's tax items to its shareholders. Because IRC Section 1361(b)(1)(D) allows a Subchapter S corporation to have only one class of stock, the credit passed through to a shareholder must be in proportion to the income passed through.
