Insights

State Tax Alert – Wisconsin Pass-Through Entity Election to Deduct State Taxes

 

State Tax Alert – Wisconsin Pass-Through Entity Election to Deduct State Taxes

On Friday, December 14, Governor Scott Walker signed 2017 Wisconsin Act 368. The law allows tax-option S corporations to elect to be taxed at the entity level for taxable years beginning on or after January 1, 2018, and partnerships to elect to be taxed at the entity level for taxable years beginning on or after January 1, 2019. 

Persons who, on the day on which an election under this paragraph is made, own more than 50% of a pass-through entity may elect, on or before the due date or extended due date of their return, to be taxed at the entity level at a rate of 7.9% of net income reportable to Wisconsin.

Practically speaking, the new law allows a federal tax deduction for Wisconsin income taxes arising from the business activities of the pass-through entity. The deduction is claimed on the entity’s federal income tax return. This mitigates, to some extent, the itemized deduction limitation imposed on state and local income taxes impacting many Wisconsin business owners. 

The election comes with the following price tags:

  1. Since the tax paid by the pass-through entity is computed at 7.9%, it exceeds the Wisconsin highest individual income tax rate of 7.65%. Weighing the tax benefits achieved, considering both federal and state, will be a must.
  2. Other than a credit for tax paid to other states by the entity on behalf of its owners, or on income tax paid by the entity to another state, Wisconsin credits may not be claimed by the pass-through entity against this income. This would include, among other things, credits such as the Wisconsin Research and Manufacturing and Agriculture Credits. However, the credit for tax paid to other states is computed using a 7.9% tax rate.
  3. The pass-through entity may not claim losses.
  4. If the tax is not paid by the pass-through entity, the Department of Revenue may collect the pro rata share of the tax from the owner.

 

Making the Election

The election applies only to S corporations for the 2018 filing year (partnerships are applicable for 2019 tax years). Wisconsin has issued the following guidance:

  • A checkbox was added to 2018 Form 5S, Part A, #7 to make the election to be taxed at the entity level.
  • A checkbox was added to 2018 Schedule 5K-1, Part B, #3 to designate that the entity made the election to be taxed at the entity level. The entity-level tax will be reported on Form 5S, Page 1, Line 7, and the tax will be computed on a new schedule, Schedule 5S-ET.
  • Schedule 5S-ET is under development. Tax-option S corporations making the election will not be able to file 2018 Form 5S until after Schedule 5S-ET is finalized and programmed (estimated to be in mid-July 2019). In general, shareholders will need to wait to file their individual income tax returns until they receive notification from the corporation as to whether the election has been made (e.g., Schedule 5K-1).
  • Underpayment interest will not apply to the additional tax due as a result of making the election for tax year 2018; however, tax-option S corporations that make the election must pay the tax due by the unextended due date of the return to avoid regular interest charges.

Revoking the Election

If persons who, on the day on which the election under this paragraph is made, hold more than 50% of the shares of a corporation that has elected to be taxed at the entity level consent, a corporation that is an S corporation for federal income tax purposes may elect, on or before the due date or extended due date of its return under this chapter, to revoke its election for that taxable year.

Entity Basis

The owner’s basis in his or her interest is computed as if the election had not been made.

Other Considerations

Wisconsin indicates that it will issue additional guidance in the January Wisconsin Tax Bulletin.  In the meantime, here are some immediate questions you may be considering:

Is the election made annually?
Yes, the language of the statute discusses revoking the election for a particular year and making the election “for that taxable year.”

Can I compute Wisconsin credits in one year, make the election, and carry those credits to the succeeding year?
Presumably, no. There is no reference in the current law indicating a credit that cannot be claimed in an election year can be carried forward to a subsequent year. 

Must a composite return be filed on behalf of owners to claim the credit for state tax paid against Wisconsin tax paid at the entity level?
Per the statute, yes.  Presumably, this will allow Wisconsin to easily verify the computation for tax paid to other states.

What if the other state does not allow the filing of composite returns? What if the owner is not eligible to participate in a composite return filing?
Under the literal reading of the statute, these taxes would not be creditable. However, Wisconsin may provide additional clarification or potential alternatives.

What if a composite return requires the addback of items such as Section 179 or 59(e) expenses? Will the higher tax paid to another state be creditable?
Wisconsin makes it clear that the credit is not allowed unless the income taxed by the other state is also considered income for Wisconsin tax purposes and is otherwise attributable to amounts that would be reportable to this state by owners. Since items such as Section 179 are deductible in computing Wisconsin income, it will likely be necessary to reduce the credit for taxes claimed.

If I fail to make an election, can I amend the return to elect or revoke an election?

Unless other guidance is issued, we should assume that the election cannot be claimed on an amended return filed after the due date or extended due date of the tax return.

As we get more guidance, we will communicate additional information.

Author(s)

Craig Cookle
Craig A. Cookle, CPA
Partner, Tax
View Profile
Linda Feirn
Linda J. Feirn, CPA
Partner
View Profile
Daryl Ohland
Daryl L. Ohland, CPA, MST
Director
View Profile