State Income Tax Deduction Limit Workaround Signed into Law in Illinois

State Income Tax Deduction Limit Workaround Signed into Law in Illinois


On August 27, Governor Pritzker signed into law Senate Bill 2531, which institutes a method for owners of Partnerships and S-Corporations (Pass Through Entities or PTE’s) to deduct income taxes beyond the Federal $10,000 limit for taxpayers who itemize deductions on their Form 1040.  This workaround has also been instituted in many other states as well.  Here’s how it works:

  • Each year from 2021 – 2025 PTE’s make an irrevocable election to have income taxes withheld and paid to the state of Illinois on all Illinois taxable income.
  • Taxes are withheld on Illinois income at a rate of 4.95% and remitted to the state in the form of quarterly estimated tax payments by the taxpayer’s PTE.
  • In a recently issued notice, the IRS has confirmed that the PTE would then be allowed to deduct those state income tax payments in determining each owner’s share of PTE income.
  • In effect, the state taxes would be ENTIRELY deductible by the PTE, rather than previously being an itemized deduction, which was limited to only a maximum deduction of $10,000.
  • The PTE owners would then be allowed as a credit on their Illinois returns their share of the taxes paid on their behalf by the PTE.

Questions remain as the Illinois Department of Revenue has yet to issue regulations that would fill in the details.  For example, how is the election made? How would the quarterly estimated tax payments work for 2021, now that it’s already September?

The workaround gets more complicated if the PTE has income in other states as well as Illinois, and if there are nonresident owners.  Because states are passing different versions of the workaround, it will be necessary to review each state’s law that relates to the PTE or nonresident owner.

Still, for many owners of partnerships and S-Corporations, this will come as welcome relief from Federal taxation.