August 28, 2019 Wisconsin Tax Appeals Commission upholds taxpayer's dividend received deduction received by a disregarded entity In Deere & Company v. Department of Revenue, WTAC Docket No. 18-I-135, (issued August 21, 2019), the Wisconsin Tax Appeals Commission (WTAC) reversed a Wisconsin Department of Revenue (DOR) assessment denying a taxpayer's dividends received deduction (DRD) for distributions received from a foreign limited partnership. The taxpayer owned a single member limited liability company (SMLLC) that was disregarded for federal income tax purposes. The SMLLC, in turn, owned all the interests in a limited partnership (LP) organized under the laws of Luxembourg. For federal income tax purposes, the taxpayer was treated as the direct owner of the interests in the LP. In 2012, the taxpayer filed a Form 8832, Entity Classification Election, with the Internal Revenue Service (IRS), electing to treat the LP as a corporation for federal income tax purposes. The IRS approved the election. For the FY2013 and FY2014 tax years, the taxpayer received distributions from the LP, which it treated as dividends and for which it claimed both a federal and Wisconsin DRD. The DOR issued a Notice of Office Audit Amount Due denying the taxpayer's claim of a Wisconsin DRD for the distribution received from the LP. The taxpayer appealed the assessment through the DOR's Resolution Unit and then to the WTAC. Both the taxpayer and DOR filed motions for summary judgment stipulating that no facts were in dispute. Accordingly, the WTAC had to determine the legal issue of whether Wis. Stat. Section 71.26(3)(j) allowed the taxpayer a DRD for the distribution it received from the LP (an affiliated foreign entity that elected to be treated as a corporation for federal income tax purposes). Wis. Stat. Section 71.26(3)(j) disconnects from the federal DRD provision and replaces it with the state's own rule that "corporations may deduct from income dividends received from a corporation with respect to its common stock if the corporation receiving the dividends owns, directly or indirectly, during the entire [tax] year at least 70% of the total combined voting stock of the payor corporation." The DOR made a two-fold argument1 that the taxpayer was not entitled to a DRD for the distribution received from the LP. First, the DOR looked to the definition of a corporation under Wisconsin law. Wis. Stat. Section 71.22(1k) defines the term "corporation" for Wisconsin tax purposes to include " … all other entities treated as corporations under [Section] 7701 of the Internal Revenue Code, unless the context requires otherwise … ." While classified as a corporation for federal income tax purposes, the DOR asserted, the LP was not a corporation for purposes of the Wisconsin DRD statute. Because the LP's ownership was represented by partnership capital interests, it could not have issued common stock, which was a condition under the statute for a dividend eligible for the DRD. Second, the DOR argued, the dividends did not qualify as common stock under the Wisconsin DRD statute. As such, they were nondeductible, even if the LP were a corporation under Wisconsin tax law and its membership interests were stock. The WTAC began its analysis by examining whether the LP was a corporation for purposes of the Wisconsin DRD statute. The WTAC noted that the federal election to be classified as a corporation has "broad ramifications." Under the federal tax law, regardless of original legal form, an entity is treated as the type of entity for which an election has been made. A partnership electing corporate classification is deemed, under the IRC, as having exchanged its partnership interests for stock (i.e., becoming a stock corporation). As such, the WTAC concluded that the LP was not only to be taxed as a corporation, it was a corporation under Wis. Stat. Section 71.22(1k). For this reason, the DOR had to accept the deemed transactions that facilitated the deemed transformation of the entity from a partnership to a corporation. Following IRS guidance, the WTAC treated the taxpayer as owning stock in a corporation and, by that stock ownership, receiving dividends for which it may claim the DRD. The WTAC then noted this was not a situation in which the "context requires otherwise" in applying the statute. While Wis. Stat. Section 71.22(3)(j) replaces the federal DRD rule with its own, the state's rule did not preclude the deduction. The WTAC rejected the DOR's argument that the payor entity had to have actual common stock versus deemed common stock to be eligible to claim a DRD for the distribution from the LP. Finally, the WTAC pointed to previous DOR guidance treating an LLC that elects to be treated as a corporation for federal purposes as a corporation for Wisconsin purposes, including treating the LLC interest as common stock. The WTAC concluded there was no basis to treat the LP interest any differently and that, as such, the DOR had to adhere to its own guidance in effect during the audit period per Wis. Stat. Section 73.16(2)(a). Implications It is unknown at this time whether the DOR will appeal the WTAC's decision to the Wisconsin Circuit Court. Taxpayers may nonetheless find this decision a welcome development, as the DOR has vigorously prosecuted this issue and numerous similar cases are still pending in the DOR's Resolution Unit. Taxpayers that have paid assessments on this issue may consider applicable statutes of limitations in claiming refunds. Update: EY has learned that the DOR intends to appeal this decision to the Wisconsin Circuit Court. ———————————————
——————————————— 1 The DOR has been pursuing this issue with other taxpayers over the last two years with numerous assessments issued and pending in the DOR's Resolution Unit. See Tax Alert 2017-1518. | |||||||||
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