Illinois Concludes that Receipts from Deemed Sale of Assets is Excluded from the Sales Factor

When selling a business, the receipts from the sale of assets can have a significant impact on the sales factor for apportionment purposes, which is why many states have special rules to address these transactions.

By Kristen Davis, SALT Associate

Businesses that operate and file income tax returns in multiple states are likely familiar with the concept of “apportionment” whereby each state applies an “apportionment percentage” to the company’s state-modified federal taxable income in order to determine the state’s share of that income.  Historically, that apportionment percentage was determined by looking at the ratios of the company’s property, payroll and sales in the state.  Today, most states now just determine the percentage based on a sales factor (i.e., the company’s sales/revenues in the taxing state divided by all sales/revenues).

During normal operational tax years, those revenues consist mostly of the company’s revenues from sales to customers in the normal course of business, whether from the sale of products or services.  However, when a significant transaction occurs, such as when a business sells all of its assets, the revenues from that transaction may be treated differently by the states for purposes of determining the sales factor.   This issue was addressed in a recent Illinois private letter ruling.[1]

The taxpayer is an Illinois corporation that manufactures and sells tangible goods, and it operates in Illinois and in other states.  It made an election under the Internal Revenue Code (“IRC”) to be treated as an S-corporation.  The taxpayer entered into an agreement with a buyer to sell all of the corporation’s stock, and the parties agreed to make an election under IRC Section 338(h)(10).  This election caused the stock transaction to be treated as a deemed sale of assets for federal income tax purposes.

The taxpayer requested a ruling to ask two very important questions.  First, whether, for state income tax purposes, the Department of Revenue (“DOR”) would follow the IRC 338(h)(10) election and treat the stock sale as a deemed sale of assets consistent with the treatment for federal income tax purposes?  Second, whether the revenues derived from the deemed sale of assets not sold in the regular course of business[2] should be excluded from the sales factor?

With regard to the 338(h)(10) election, the DOR noted that Illinois income tax rules conform to federal S-corporation elections and generally provide that items of income and deduction should be taken into account for state income tax purposes as they are for federal income tax purposes.  Therefore, the DOR concluded that it would conform to the 338(h)(10) election and treat the transaction as a deemed as a sale of assets for Illinois income purposes.

Turning to the second issue, the DOR pointed to its regulation which states that “[w]here gross receipts arise from an incidental or occasional sale of assets used in the regular course of the person’s trade or business, such gross receipts shall be excluded from the sales factor.  For example, gross receipts from the sale of a factory or plant will be excluded.”[3] In this case, the Taxpayer represented that the sale of assets which it does not normally sell in its regular course of business qualifies as an incidental or occasional sale since no similar sale occurred in the Taxpayer’s history.  Therefore, the DOR concluded that the receipts from the sale of such assets is excluded from the numerator and denominator of the sales factor.

Ideally, when businesses engage in transactions that are not in the ordinary course, the state income tax consequences should be addressed in advance because the typical rules may not apply, and there may be ways to structure the transaction to produce favorable state tax results.  Aprio’s SALT team has experience addressing income tax apportionment issues in the context of business transactions and can assist your company to make sure that it is engaging in the most tax-efficient structure.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Kristen Davis, SALT associate, at kristen.davis@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the Nov./Dec. 2019 SALT Newsletter.

[1] Illinois Private Letter Ruling IT-19-0003-PLR (August 12, 2019).

[2] These assets typically consist of assets other than inventory (i.e., those assets that the taxpayer is not normally in the business of selling).

[3] 86 III. Admin. Code 100.3380(c)(2).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.