Wisconsin passes legislation to offset Tax Cuts and Jobs Act limits on individual state income tax deduction

December 17, 2018|Steven Koritzinsky

Starting for 2018 tax years, individuals are now limited as to how much they can deduct in state income and property taxes. In prior years, the deduction was unlimited but starting in 2018, the deduction is limited to $10,000 in total. Several states have attempted creative approaches to circumvent this Tax Cuts and Jobs Act (TCJA) provision that limits an individual state income tax deduction. Wisconsin is now one of them.

The basic premise of this workaround is that while the TCJA’s state income tax deduction cap applies to individuals, it does not appear to apply to businesses. Thus by shifting the incidence of the state’s income tax on individual pass-through entity (PTE) owners from the individual to the business, a PTE converts a capped deduction to an uncapped deduction.

Wisconsin

On December 14, Wisconsin Senate Bill 883 was signed into law by Governor Walker. This law allows pass-through entities (PTE), which are LLCs, S corporations, and partnerships, to elect to be taxed at the entity level for purposes of Wisconsin income and franchise taxes. A pass-through entity that makes this election is taxed at the corporate rate of 7.9% versus the highest individual tax rate of 7.65%. The entity making this election may not claim losses and tax credits except for the credit for income taxes paid to other states. The PTE is still considered a pass-through entity and the adjusted basis of the entity’s partners, shareholders, or members is determined as if the election were not made. This election must be made by persons holding more than 50% of the ownership of the flow-through entity. The election is made by a new check box on the S corporation return and each Form 5K-1 has a box to indicate the election has been made.

For Wisconsin tax-option S corporations, the election is available for tax years beginning in 2018, while for other flow-entities, such as partnerships and limited liability companies treated as partnerships, the election is available for tax years beginning in 2019.

The Wisconsin Department of Revenue quickly released some much needed guidance on Monday, December 17, 2018.

Observations

  • Because the only credit that a PTE may claim against this Wisconsin entity-level income tax is the credit for income taxes paid to other states, the loss of the ability to claim the manufacturing and agricultural credit (MA credit) and research and development credit (R&D) may outweigh the resulting federal individual income tax benefit. As a result, owners of PTEs who generate significant Wisconsin MA credits and R&D credits will need to carefully evaluate the impact of this election before electing into it. In addition, many taxpayers have received Wisconsin Economic Development Corporation (WEDC) tax credits and it is unknown at this point if those credits are disallowed too.
  • The fact that Wisconsin has historically permitted S corporations to elect C corporation status for state purposes may cause some confusion regarding how this new entity-level income tax election is different from that election. Any state income tax deduction limitation workarounds of applying an “entity level” tax to a “pass-through entity” may raise theoretical questions about what makes a company a “pass-through.” The IRS has challenged and negated other states’ attempts for workarounds.
  • Owners of PTE have already made Wisconsin estimated tax payments based on the pass-through income being reported on their return and will have to wait until they file their 2018 tax returns to receive their refunds.
  •  S corporations that choose to make the election for tax year 2018 will not be subject to underpayment interest as a result of the election and will not be required to make estimated tax payments for 2018. The S-corp will need to pay the tax due by the unextended due date of the return in order to avoid interest for the period between the unextended due date of the return and the date the tax is paid. However, estimated tax payments will be due for 2019 tax years. Guidance will be needed on how to make estimated tax payments.
  • The entity level tax for S corporations will be calculated on Wisconsin Schedule 5S-ET. The Department of Revenue estimates that this form will be ready on July 19, 2019. This will REQUIRE that all S-corps that want to make this election extend their tax returns until the form is ready. The Department of Revenue guidance also says “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).”
  • A few unknowns still remain. If a cash basis S-corp does not pay any of this tax until 2019, will it lose the ability to deduct the 2018 taxes that it elects to pay on its 2018 tax return or will they only be deductible in 2019 when paid? That is not determined at this point. Accrual basis PTE can likely deduct the 2018 taxes on the 2018 return even if not paid. Also, does this election negate the requirement of Wisconsin pass-through withholding for nonresidents?

We will continue to monitor the situation. The Department has announced that more information will be in the January 2019 Wisconsin Tax Bulletin.

Please contact us for assistance.


Steven Koritzinsky, CPA, Director – SALT, is a seasoned state and local tax director with extensive experience in both state and local tax and audit controversy. He is also skilled in franchise/income, and sales/use taxes.