Illinois Pass-Through Entity Tax (PTE): How the Election Works Now That It Is Permanent

Illinois's pass-through entity tax has moved from a temporary solution to a permanent fixture in the state's tax code. Effective December 12, 2025, the state has locked in a 4.95% entity-level tax election for partnerships and S corporations, replacing an earlier sunset provision. This is not a mandatory tax, it is an election. If you own an S corporation or partnership in Illinois, understanding how this tax works and whether to take the election is now a core business decision.

What Is the Illinois Pass-Through Entity Tax?

The Illinois pass-through entity tax (often called Illinois PTE tax or PTET) is an optional, entity-level income tax that allows partnerships and S corporations to pay tax at the entity level instead of passing income through to owners. The tax rate is a flat 4.95%, a number that sounds precise until you understand why it exists: it is designed to function as a workaround for the federal SALT cap.

Under federal tax law, the SALT (state and local tax) deduction is capped. Federal legislation in 2025 changed the cap amount and added an income phase-down, so confirm the current figure with the IRS or your tax advisor. For high-income business owners, especially those in high-tax states, this creates a significant tax burden. By allowing the entity itself to pay Illinois income tax and giving owners a corresponding credit, owners can treat the 4.95% entity payment as a business deduction rather than a personal state income tax, potentially avoiding the SALT cap limitation.

This is strategic tax planning, not tax avoidance. The mechanism is legal, established by state statute (35 ILCS 5/201(p)), and now permanent as of PA 104-453.

The Original Sunset and Why Permanence Matters

Illinois first introduced the pass-through entity tax election as a temporary tool. It was originally set to expire for tax years beginning January 1, 2026. The original sunset created uncertainty: business owners could not plan long-term strategies around a tax election that might disappear. Accounting and tax planning become difficult when a core assumption has an expiration date.

PA 104-453, effective December 12, 2025, removed the sunset. The election is now permanent. This shift moves the Illinois PTE tax from temporary relief to a permanent part of the state's tax structure. For owners of pass-through entities, permanence means you can now factor this election into ongoing business strategy without the risk of sudden rule changes.

How the Election Works

The Illinois pass-through entity tax is an annual election, not a one-time choice. Here is how it works in practice.

Making the Election

You make the PTE tax election each year on your annual return. For partnerships, this is Form IL-1065 (Partnership Replacement Tax Return). For S corporations, this is Form IL-1120-ST (Small Business Corporation Replacement Tax Return). The election applies to the specific tax year being reported.

Once you make the election for a given tax year, it is irrevocable for that year. You cannot change your mind mid-year or after filing. This means the decision to elect the 4.95% entity tax must be made deliberately, ideally with your accountant or tax advisor, before filing the return.

For the following year, you face the election again. You can elect in year one, decline in year two, and elect again in year three if circumstances change. The flexibility is annual, not permanent.

Tax Calculation

If you elect the pass-through entity tax, your entity calculates Illinois income tax at 4.95% on the entity's net income (or, as of tax year ending 12/31/2026, on a distributive-share or Illinois-sourced income base, a new option for partnerships described below).

The entity pays this tax directly to the Illinois Department of Revenue. From the entity's perspective, this is a straightforward calculation: net income multiplied by 4.95%.

Owners still report their share of the income on their own Illinois returns, but they receive a credit for the entity-level tax.

The Owner Credit

This is where the election becomes valuable. Owners of the entity receive a credit equal to 4.95% of their distributive share of the entity's income. This credit is claimed on the owner's individual Illinois return.

Example: A partnership elects the PTE tax and pays $50,000 in entity-level tax. Partner A's distributive share is 40% of the entity's income. Partner A receives a credit of $50,000 multiplied by 40%, or $20,000. This credit offsets Partner A's individual Illinois income tax liability.

The credit cannot exceed the owner's share of the entity-level tax actually paid. If the credit is larger than the owner's Illinois income tax for the year, the excess is treated as an overpayment under 35 ILCS 5/909.

Why This Matters for the SALT Cap

The real benefit of the Illinois pass-through entity tax is not the savings on the entity payment itself. The benefit lies in how the payment is treated at the federal level.

When an S corporation or partnership pays business income tax at the entity level (rather than passing it through to owners who then pay individual income tax), the entity payment may be deductible as a business expense. Business expenses are not subject to the SALT cap. Personal state and local taxes are.

This allows high-income owners to effectively "deduct" more state tax than the SALT cap allows at the federal level, working around the SALT limitation. A partner or S corp owner with a 4.95% entity tax payment can treat that payment as a business deduction rather than counting it against their personal SALT cap.

The federal savings depend on each owner's federal tax bracket and SALT position, so have your tax advisor run the numbers.

This is not available to sole proprietors or C corporations. Sole proprietors cannot elect the entity tax because they have no entity. C corporations already pay tax at the entity level and do not file individual returns, so the SALT cap question does not apply to them in the same way.

New Flexibility for Partnerships (Tax Year Ending 12/31/2026 and Later)

As of the 2026 tax year, partnerships have a new choice beyond simply electing or declining the PTE tax. They can now choose the income base on which to calculate the 4.95% tax.

Full Distributive Share Base

Partnerships can calculate the entity tax on their full distributive share of partnership income. This is the broadest base and results in the highest entity tax liability.

Illinois-Sourced Income Base

Alternatively, partnerships can elect to calculate the entity tax only on income sourced to Illinois. This results in a lower entity tax liability for partnerships that have income from outside Illinois.

Which option is better depends on the partnership's income allocation and sourcing rules. A partnership with significant out-of-state income may benefit from the Illinois-sourced base, while a partnership operating entirely within Illinois may see no difference. Confirm the mechanics of this election with your tax advisor before filing, as the calculation rules can be complex.

The Replacement Tax Still Applies

Illinois also imposes a personal property replacement tax (PPRT) at 1.5% on pass-through entity income. This tax is separate and is still owed, regardless of whether you elect the 4.95% pass-through entity tax.

If you elect the PTE tax, the entity owes the 4.95% entity-level tax and the 1.5% replacement tax is still owed separately. Confirm how the two bases are computed with the Illinois Department of Revenue or your tax advisor.

Confirm the exact mechanics of how these two taxes interact in your specific situation. The calculation rules can vary depending on the type of entity, income type, and whether you have elected any other tax options. Your accountant or Illinois tax advisor can provide the precise calculation for your business.

Who Should Elect the Pass-Through Entity Tax?

The election is most valuable for:

• High-income owners of S corporations and partnerships (those in the top federal tax brackets)
• Owners subject to the federal SALT cap limitation
• Owners with enough federal income tax liability to benefit from the federal deduction
• Owners with stable entity income (the election is annual, so changing circumstances may affect the decision year to year)

The election is less valuable or may not be worth considering for:

• Lower-income owners (the federal tax savings are smaller)
• Entities with losses or minimal income (there is no tax liability to offset)
• Owners whose other state and local taxes do not exceed the SALT cap

This is a strategic election, not a one-size-fits-all rule. The decision requires analysis of your specific federal and state tax situation.

Compliance and Filing

If you elect the Illinois pass-through entity tax, your entity must file the appropriate annual return and make the election on the form. For partnerships, this is Form IL-1065. For S corporations, this is Form IL-1120-ST. Both forms are available on the Illinois Department of Revenue website at https://tax.illinois.gov/.

The entity files these returns directly with the Illinois Department of Revenue. Owners then claim the corresponding credit on their individual Illinois Form IL-1040 returns.

For calendar-year entities, partnership returns are due April 15 and S corporation returns are due March 15 (35 ILCS 5/505). An electing entity must also pay estimated tax for the year if the amount can reasonably be expected to exceed $500 (35 ILCS 5/201(p)(9)).

No additional registration or approval is required. You simply make the election on the return itself.

Key Deadlines and Timing

The election has been available for tax years ending on or after December 31, 2021. PA 104-453, effective December 12, 2025, removed the sunset that would have ended it for tax years beginning on or after January 1, 2026, so calendar-year entities can keep electing for 2026 and later years.

If your entity operates on a fiscal year, confirm how the effective date applies to your specific situation. Confirm the rules with your tax advisor or the Illinois Department of Revenue.

Each year, the election must be made (or not made) by the due date of the return. There is no separate election deadline before filing. Make the decision as part of your tax return preparation process.

Important Limitations and Considerations

The Illinois pass-through entity tax is a state-level election. It does not change which federal returns you file. Your entity still reports income on the federal 1065, 1120-S, or relevant form, and owners still report their distributive shares on their individual federal returns.

The credit the owner receives for the entity tax payment is an Illinois credit only. It cannot be used against federal tax liability.

The election is irrevocable for each tax year. If you elect and circumstances change mid-year, you cannot undo the election for that year. Plan ahead.

The mechanics of the 1.5% replacement tax in combination with the 4.95% PTE tax can be complex. Do not assume you understand the exact calculation without confirming with your accountant. State tax law details matter, and mistakes in calculation or form filing can result in penalties and interest.

Resources for More Information

For official guidance on the Illinois pass-through entity tax and related forms:

• Illinois Department of Revenue: https://tax.illinois.gov/ (searchable for PTE tax guidance and forms)
• Form IL-1065 (Partnership Replacement Tax Return): Available on the Illinois Department of Revenue website
• Form IL-1120-ST (Small Business Corporation Replacement Tax Return): Available on the Illinois Department of Revenue website
• Statute 35 ILCS 5/201(p): The legal basis for the credit

The Illinois Department of Revenue may also publish notices or updates on the permanent status of the PTE tax. Check their website for the most current guidance if you are filing a return after the permanence rule takes effect.

Final Recommendations

Now that the Illinois pass-through entity tax is permanent, the decision to elect is no longer complicated by sunset uncertainty. You can build this into your long-term tax strategy. However, the decision still requires analysis of your specific situation.

The best approach is to discuss the election with a qualified accountant or tax advisor who understands both Illinois and federal tax law. They can calculate whether the election will result in federal tax savings in your situation and whether those savings exceed any additional compliance costs or risks.

Do not assume the election is automatically beneficial. Do not assume it is not worth considering. Let your specific numbers guide the decision.

Disclaimer

This article is informational only and does not constitute legal, accounting, or tax advice. The Illinois pass-through entity tax involves complex federal and state tax rules that vary significantly based on individual circumstances. Before making any election or filing any return, consult with a qualified tax professional, certified public accountant (CPA), or attorney licensed to practice in Illinois. Tax rules and forms change frequently. Confirm that the information in this article is current as of your filing date, and verify all calculations and requirements with the Illinois Department of Revenue or a qualified tax advisor.