by James G. Wargo (Summer 2016)
On April 19, 2016, the Illinois Department of Revenue (IDOR) announced that it had discovered a misallocation of revenues to the Personal Property Replacement Tax (PPRT) Fund that began two years ago. This has resulted in an overpayment of an estimated $168 million to local governments throughout the State that receive PPRT disbursements. IDOR stated that it would be working with the impacted taxing districts to establish a plan to recapture any overpayments. A complete list of the local governments affected by the allocation error can be found at IDOR’s website at: tax.illinois.gov. Since the announcement of the overpayments, IDOR has provided a further explanation of how the misallocation error occurred.
First, a little background information is in order. The Illinois General Assembly enacted the PPRT to replace the revenues lost by local governments when their power to impose personal property taxes on corporations, partnerships and other entities was abolished under the Illinois Constitution of 1970. All Illinois corporations, including S corporations, partnerships and trusts, are subject to the PPRT under the Illinois Revenue Code. Revenues collected by the IDOR under the PPRT are deposited by the State into a separate PPRT Fund. Revenues deposited in the PPRT Fund are distributed to local governments throughout the State.
According to the IDOR, the General Assembly’s enactment of Public Acts 95-707 and 98-478 are the primary source of the discovered misallocation. Pursuant to Public Act 95-707, S-corporations, partnerships, and trusts are required to make Illinois income tax payments on behalf of nonresident shareholders, partners and beneficiaries (collectively referred to as “nonresident owners”). These payments made on behalf of such nonresident owners are known as “pass-through withholding payments.” These pass-through withholding payments are not to be deposited in the PPRT Fund and are not subject to distribution to local governments.
In order to make the required pass-through withholding payments, the IDOR initially created Form IL-1000. Under Form IL-1000, if the pass-through withholding payments were sufficient to satisfy the respective nonresident owner’s State income tax liability, no income tax return was necessary. Two problems resulted from the use of Form IL-1000. The first problem was that the tax form did not allow for a refund. The only way to obtain a refund was for the business entity that over withheld to file an Illinois income tax return, which defeated one of the purposes of Form IL-1000. The second problem was the fact that many business entities did not know they needed to file the Form IL-1000 because the form was separate from the business entity’s replacement tax returns.
In order to address the problem associated with Form IL-1000 to allow nonresident owners to obtain a refund for over withholdings of pass-through withholding payments without filing an Illinois income tax return, the General Assembly enacted Public Act 98-478, which became effective on January 1, 2014. This Act adjusted the pass-through withholding to be reported and paid the PPRT directly on the following tax returns: (1) Form IL-1120-ST (S-corporations); (2) Form IL-1065 (Partnerships); and (3) Form IL-1041 (Trusts). This change also resulted in the elimination of a number of tax forms, including Form IL-1000.
During a recent tax system modernization initiative review, the IDOR discovered that the consolidated forms resulted in the pass-through withholding payments made on behalf nonresident owners to be misallocated to the PPRT Fund. These misallocated pass-through withholding payments were subsequently erroneously distributed to the local governments.
According to the IDOR, PPRT payments to local governments totaled over $1.3 billion in 2014 and $1.4 billion in 2015. A majority of the PPRT is paid by C-corporations, which do not pay the pass-through withholdings. The payments from C-corporations have been properly classified as PPRT and deposited in the PPRT Fund. S-corporations, partnerships, and trusts are required to pay the pass-through withholding as well as the PPRT. The misclassification of the pass-through withholding payments represent approximately 6% of the total distributions from the PPRT Fund.
The IDOR is currently in the process of confirming the amount of overpayments to the respective local governments and anticipates that it will begin to recoup the overpayments over an extended period of time beginning with the January 2017 allocation.
IDOR has not yet identified whether it will collect the overpayments via invoice or by withholding from future PPRF payments. The IDOR has signaled that further information on this overpayment issue would be released in the near future.