Wisconsin Enacts Election Permitting Pass-Through Entities to be Taxed at the Entity Level

January 2019

Summary

On December 14, 2018, Wisconsin enacted S.B. 883 (2017 Wisconsin Act 368), to allow pass-through entities (PTEs) to elect to be taxed at the entity level.  If a PTE makes the election, then it will be taxed at a rate of 7.9 percent on its net income apportioned and allocated to Wisconsin.  S Corporations are eligible to make the election for tax years beginning on or after January 1, 2018, while all other PTEs can make the election for taxable years beginning in 2019.
 

Details

Background
Wisconsin, like the federal government and most (but not all) states, treats S corporations, partnerships, and limited liability companies (LLCs) taxed as partnerships for federal tax purposes, as PTEs.  PTEs are not subject to income or franchise tax at the entity level.  Instead, income, gain, deductions, and other tax items pass through to the PTE’s owners or shareholders.  Act 368 now gives PTEs the option to be taxed at the entity level, or to continue their treatment as PTEs for Wisconsin income tax purposes. 
 
The Election
“Persons” who hold more than 50 percent of the capital and profits interests in a partnership (or LLC taxed as a partnership for federal tax purposes) must consent to an election by a partnership or LLC to be subject to the Wisconsin PTE tax.  Similarly, owners of more than 50 percent of the shares of an S corporation must consent to the election.    The annual election must be made on or before the due date or extended due date of the PTE’s return for each taxable year.  If the election is timely made, then the PTE is taxed at the Wisconsin corporate income tax rate of 7.9 percent on net income reportable to Wisconsin.
 
PTE Tax Treatment in General
The new Wisconsin PTE tax presents a number of questions and considerations, including the following:
  • The character of income, along with the rules of apportionment and allocation, remain the same as if the election was not made.  That is, the PTE will apply the Wisconsin corporate income tax apportionment and allocation provisions.  The effect of the PTE’s income, gain, loss, etc. on a PTE owner’s tax basis in their interest is determined as if the PTE election had not been made.
  • Tax credits available to PTE owners cannot be used to offset the PTE tax of the entity.  The only tax credits that will be allowed the PTE will be net income or franchise taxes paid by the PTE to another state, including income taxes paid on behalf of the owners by the PTE that are Wisconsin residents on other state composite tax returns.  However, the other state tax credits are limited to the Wisconsin 7.9 percent PTE tax rate.  The income taxed by another state must also be considered income for Wisconsin tax purposes “and is otherwise attributable to amounts that would be reportable to this state by shareholders, partners, or members . . . that are residents of this state . . .”
  • The PTE may not carryover losses.
  • Provisions of state law relating to estimated payments and underpayment interest apply beginning in 2019 and later years.
  • If a PTE fails to pay the amount of tax owed with respect to income as a result of the election, the Wisconsin Department of Revenue may collect the amount from the PTE owners based on their proportionate share of such income.
 
Compliance
The 2018 Wisconsin Form 5S contains instructions for S corporations electing to pay the new PTE tax for the 2018 tax year.  The election is made by using a new checkbox added to the 2018 Form 5S, Part A, #7.  Similarly, a new checkbox was added to the 2018 Schedule 5K-1, Part B, #3 to signal to a shareholder that the election was made to be taxed at the entity level.  A new schedule, Schedule 5S-ET, will be used to compute the PTE tax.  According to the Department of Revenue, Schedule 5S-ET is currently under development, and it is expected to be finalized on July 19, 2019.  S corporation shareholders will have to wait to file their individual Wisconsin returns until notified by the S corporation that the election has been made via the new Schedule 5K-1.  For the 2018 tax year, underpayment interest will not apply to the additional tax due as a result of making the election.  However, according to the Department of Revenue’s Form 5S instructions, S Corporations making the election are required to pay the tax by the un-extended due date to avoid regular interest charges.
 
Given that Schedule 5S-ET is not expected finalized until July, S corporations with Wisconsin filing obligations should consider filing extensions.
 

BDO Insights

  • The 7.9 percent rate on the new entity-level tax for PTEs is the same as Wisconsin’s corporate income tax rate.  The highest individual tax rate is 7.65 percent in Wisconsin.  As a result, an analysis of the estimated tax savings should be done to determine if the election would be beneficial for the PTE and its owners. 
  • There are several beneficial provisions of the new law that could make the election attractive to most taxpayers.  The election is an annual election that can be made on a year-to-year basis.  A new analysis should be completed each year to determine whether the election is beneficial.
  • However, there is no carryover of PTE losses allowed.  And, the PTE can only claim a Wisconsin tax credit for entity-level taxes, including composite return taxes, paid to another state.  These potentially unfavorable provisions must be taken into consideration when deciding whether a PTE should make the annual election.
  • Non-resident owners of a PTE electing to pay the Wisconsin PTE tax also should review their resident state rules concerning the ability to claim entity-level taxes paid by their PTE to Wisconsin (and other states).
  • There are a number of other uncertainties and questions presented by the new Wisconsin optional PTE tax that PTEs and their owners/investors will need to address prior to making the election.
  • As part of legislation enacted earlier in 2018, Wisconsin already decouples from most of the federal tax reform known as the Tax Cuts and Jobs Act, including the IRC Section 163(j) business interest limitation and the IRC Section 199A qualified business deduction.
 
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