Elective Pass-Through Entity Tax Law Passed in Wisconsin

Governor Scott Walker signed 2017 Wisconsin Act 368 on December 14, 2017. It allows tax-option (S) corporations to elect to be taxed at the entity level for taxable years beginning on or after Jan. 1, 2018, and all other pass-through entities to make this election for years beginning on or after Jan. 1, 2019.

The said law was passed as a workaround to the $10,000 federal cap on the state and local tax (SALT) deduction in tax years 2018 to 2025.  The said cap has effected a sudden increase in tax liabilities, especially to those in high tax states.

For a better view of this new Wisconsin law, here are some things you need to know.

What is A Pass-Through Entity (PTE)?

A pass-through or flow-through entity is a business entity that passes all of its income, gain, deductions, and consequently, its tax liabilities, through to the owners and investors of the business. To illustrate, an ordinary business entity pays corporate tax on its revenues and its owners or investors are liable for their personal income tax. On the other hand, since a PTE’s income is passed on to the owners or investors, the entity is not liable for corporate tax, and the owners or investors shoulder the tax liability on the income passed on to them and pay them as part of their personal income tax.

Pass-through entities are sole proprietorships, partnerships (limited, general, and limited liability partnerships), LLCs, and S Corporations.

What is An Elective PTE Tax and Why Enact It?

This optional tax allows pass-through entities to shift the burden of paying state income taxes to the entity. States are enacting laws creating this tax because it can be fully deducted by the entity for federal tax purposes.

What Are SALT Deductions?

Deduction on state and local taxes (SALT) is a device used to avoid double taxation. The taxes covered under this deduction are:

  1. Income taxes;
  2. General sales taxes (if elected instead of income taxes);
  3. Real and personal property taxes.

Prior to the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), taxpayers can deduct an unlimited amount of SALT from their federal returns. Historically, SALT deduction is highest in high-tax states, so to level the playing field for taxpayers, the TCJA imposed a $10,000 cap for single taxpayers and married couples who are filing jointly ($5,000 for married taxpayers who are filing separately).

How Would The 2017 Wisconsin Act 368 Affect PTEs and The Federal Cap?

The law creates an elective 7.9% entity-level income tax.  Paying this tax at the entity level provides an option to reduce the impact of the Federal $10,000 limit on individual deductions for state and local taxes paid.  The Wisconsin tax paid at the entity level may provide a deduction to the pass-through entity, computed without regards to the Federal $10,000 individual deduction limitation. 

How Can PTEs Make The Election?

This election requires the consent of the majority of the PTE’s ownership and is made annually by the due date or extended due date of the entity’s Wisconsin income tax return.  There are limitations related to this election, including the ability to use credits and deduct losses.

PTE Tax Treatment

Here are some points to keep in mind in the treatment of PTE tax, as provided under the Wisconsin Legislative Council Act Memo:

  1. The situs of the income is determined as if the election was not made.
  2. Offsetting PTE tax with the owners’ tax credits is not allowed. Only income and franchise taxes paid to another state are allowable as tax credits for the entity.
  3. Tax credits on income and franchise taxes paid to another state are limited to the PTE tax rate of 7.9%.
  4. Loss carry-forward may not be claimed.
  5. Provisions of state law relating to estimated payments and underpayment interest apply beginning in 2019 and later years.
  6. Upon a PTE’s failure to pay the amount of tax owed with respect to income as a result of the election, the Department of Revenue may collect the amount from the partners based on their proportionate share of such income.

This elective PTE tax may not be beneficial to everyone, and we have developed criteria and tools to assist you in evaluating this opportunity and potential tax savings. Contact your MBE CPAs, LLP tax professional with questions on this election and its potential impact on you.

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MBE CPAs PPP2 Qualification resource sheet can be downloaded here.