Authored by Alyssa Geracie, Donna Scaffidi and Jon Skavlem
On Jan. 25, 2019, the Wisconsin Department of Revenue (WDOR) issued frequently asked questions (FAQ) related to the Wisconsin pass-through entity tax created by 2018 Act 368. There were notable clarifications to earlier guidance.
As a reminder, the pass-through election can be taken by S corporations, effective for taxable years beginning on or after Jan. 1, 2018. Partnerships and limited liability companies may pursue the election effective for taxable years beginning on or after Jan. 1, 2019.
- Election – The election to be taxed at the pass-through entity level must be made annually on or before the extended due date of the Wisconsin Form 5S. This election can be revoked by filing an amended Form 5S on or before the extended due date. Please note, there is no official form to make a pass-through entity tax election. Schedule 5S-ET, Entity-Level Tax Computation, is expected to be ready July 19, 2019. Please be aware Form 5E, Election by an S Corporation Not Be Treated as a Tax-Option Corporation, should not be completed. This election is fundamentally separate from the election made on Schedule 5S-ET.
- Shareholder notification – An electing S corporation should check Box #3 in Part B of Schedule 5K-1 to indicate to the shareholder that the election has been made. While the WDOR is not requiring signatures of consent on the return, the electing S corporation should document that consent is received from shareholders who hold an aggregate of more than 50 percent of the shares. The WDOR is not planning on releasing an official “consent” form. Electing S corporations should have in their files contemporaneous documentary evidence that a timely, valid pass-through entity election has been made to meet an auditor’s standard of proof. This could entail a resolution entered into the board of director minutes detailing the outcome of the consent vote and/or written, signed consents from the requisite number of shareholders. Other forms, e.g., electronic consents, may be acceptable but we recommend that electing S corporations and their shareholders err on the side of caution in supporting their annual consent election.
- Estimated payments – The WDOR will not apply payments made by individual shareholders to the liability of the electing S corporation. The WDOR will move nonresident PW-1 payments to entity-level income tax payments if the payments were made by an electing S corporation. A written request to move payments may be submitted through email to DORIncomePassThroughComposite@wisconsin.gov. The electing S corporation must make an extension payment using 2018 Form Corp-ES by March 15, 2019. Underpayment interest and penalties associated with the entity-level tax liability of an electing S corporation will be waived for the 2018 tax year only (as long as the extension payment is timely made). In its FAQ, the WDOR is instructing individual shareholders of electing S corporations wait until they receive a Schedule 5K-1 to file an individual return and be refunded tax.
- Long-term capital gains – An electing S corporation may not claim the Wisconsin 30 percent or 60 percent long-term gain deduction.
- Capital gain exclusion for qualified businesses – An electing S corporation may not claim the capital gain exclusion as it can be claimed only by an individual. The electing S corporation may still register to be a qualified business.
- Capital loss limitation – An electing S corporation may claim the $3,000 federal capital loss limitation, not the $500 Wisconsin capital loss limitation. Please note, the net capital loss cannot be passed through to a shareholder. Unused capital losses may be carried forward by the S corporation.
- Passive losses – An electing S corporation is subject to the federal passive loss limitations of section 469 as modified by the Wisconsin statutes. It is required to determine the characterization of passive income or loss as if the pass-through entity election has not been made. As a result, an electing S corporation must ascertain how each of its shareholders will classify gains and losses, i.e., active versus passive. Passive losses cannot be passed through to shareholders. Suspended passive losses can be carried forward and offset by the S corporation against passive income in a future electing year.
- Credits taken by electing S corporation – The only credit an electing S corporation can take is a credit for taxes paid to other states. The WDOR has interpreted this to mean entity-level state income and composite tax. Pass-through withholding taxes on behalf of shareholders does not constitute a net income or composite tax and is therefore ineligible. Additionally, the WDOR cast doubt on the ability to use entity-level taxes when they constitute a deemed return for the shareholders, e.g., Illinois and Utah.
- Credits passed through to shareholders – Apart from the credit for taxes paid, an electing S corporation may pass credits through to its shareholders. There may be additional limitations at the shareholder level to utilize these credits. For example, the Wisconsin manufacturing credit can be passed through to a shareholder. However, the manufacturing credit can only be offset against tax from qualified production activities income (QPAI). Because the income was taxed to the electing S corporation and no QPAI is taxed at the shareholder level, the shareholder cannot claim a credit. Additional credits, such as the Wisconsin research credit and WEDC credits, can be passed to a shareholder and claimed on his/her individual return. Credits passed through to individuals and not used in the current tax year can be carryforward pursuant to their rules.
Officials from the WDOR indicated it has not sought guidance from the IRS as to whether or not the “Wisconsin workaround” will be permitted.
A full list of the common questions and WDOR guidance can be found here: https://www.revenue.wi.gov/Pages/FAQS/ise-scorp-determinc.aspx
For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.