On July 15th, Illinois Governor Pat Quinn signed the Emergency Budget Implementation Act of Fiscal Year 2010. This Act funded Illinois’ budget mainly with borrowing, but also contained a hidden potential tax increase for partnerships operating in Illinois.
Background. Partnerships and LLCs taxed as partnerships doing business in Illinois are subject to a 1.5% Replacement Tax on their base income apportioned to Illinois. The calculation of base income included a subtraction for “personal service income or reasonable allowance for compensation of partners.” This subtraction allowed certain partnerships to reduce their base income, effectively lowering or eliminating their Replacement Tax liability.
New Law. For tax years ending on or after December 31, 2009, the Act has eliminated the base income subtraction for “personal service income or reasonable allowance for compensation of partners.” The subtraction has effectively been replaced by a reduction in base income for “guaranteed payments for personal services of that partner.”
Planning Idea. Service partnerships earning ordinary income subject to self-employment tax may want to consider paying partners guaranteed payments. Guaranteed payments would still be subject to self-employment, which is the same treatment as the ordinary income; however, now the partnership would not subject itself to the Illinois Replacement Tax on that income. (Please note that guaranteed payments must be properly documented and meet the Internal Revenue Code definition.)
This is a significant change that will increase the Illinois Replacement Tax liability for a large number of taxpayers. We will contact affected clients to discuss strategy and how this will impact you. As always, if you have any questions, please give us a call.