On June 7, 2023, Illinois Governor J.B. Pritzker signed into law Senate Bill 1963, significantly changing the state’s qualified investment partnership provisions. Specifically, the law modifies the definition of “investment partnership” and “qualifying investment securities,” expanding the designation to more taxpayers. In addition, the legislation broadens the qualifying tests and requires these partnerships to report and withhold on Illinois-sourced income on nonresident partners.
The changes brought about in S.B. 1963 will result in more entities qualifying as investment partnerships, which would bring more planning opportunities around the replacement tax, as well as related compliance requirements, to discuss with your advisers.
For tax years ending on or after December 31, 2023, S.B. 1963 modifies the definition of an investment partnership by modifying the gross income test. Now, 90% of an investment partnership’s gross income may consist of “interest, dividends, gains from the sale or exchange of qualifying investment securities and the distributive share of partnership income from lower-tier partnership interest meeting the definition of ‘qualifying investment security.’” This expanded gross income test definition excludes partnerships operating at a federal taxable loss.
This change is important, as investment and private equity funds that own operating partnerships may now meet the gross income test — if the income from those partnerships, when combined with other qualifying investment security income, exceeds 90% of an individual fund’s gross income.
The definition of a qualifying investment security now includes any partnership interest that qualifies as a security within the meaning of the tax code. This includes any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest and a long list of others. The revised definition could mean that operating partnerships held by investment funds and private equity could be a qualifying investment security.
In addition, the legislation removes the business test, which previously required that a partnership not be a dealer in qualifying investment securities. This change may allow certain broker/dealers to meet the definition of a qualified investment partnership.
What does not change with this new legislation is that a qualifying partnership must still have at least 90% of the cost of its total assets consist of qualifying securities, deposits at banks and equipment that is reasonably necessary to carry on the business activities as an investment partnership.
S.B. 1963 adds a requirement for qualified investment partnerships to withhold tax for nonresident partners, such as nonresident individuals, and nonresident trusts, corporations and partnerships. The withholding rates remain the same as they are under the existing nonresident withholding tax provisions. The new twist is that if a partner in the qualified investment partnership is a partnership or S Corporation, then withholding is at the individual rate of 4.95%, versus the partnership/S Corporation withholding rate for non-investment partnerships of 1.5%.
An important item to note with this new provision is that Form IL-1000-E, Certificate of Exemption for Pass-through Withholding, is no longer allowed. The provision also does not allow nonresident individual partners to claim a credit for taxes paid, unless the income from the qualified investment partnership is considered business income to the partner. However, there is no requirement that a nonresident individual partner with only nonbusiness income from a qualified investment partnership file a personal Illinois return.
Also of note, an entity that now qualifies as a qualified investment partnership under the new law is no longer subject to the Illinois replacement tax. These new provisions could be significant for private equity funds who own operating partnerships subject to the replacement tax.
S.B. 1963 provides more taxpayers the opportunity to qualify as an investment partnership not subject to replacement tax. However, the new investment partnership withholding requirements may create additional compliance and tax burdens on investment partnerships and their owners who historically have not had Illinois withholding obligations. Work with your tax advisers closely to determine the impact to your business.
Contact Hannah Prengler, Jayne Callahan or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.