This article was originally written for the Business Law Section blog of the State Bar of Wisconsin and appears here with the permission of the State Bar and the article’s authors.
James W. DeCleene,Marquette 2015, is an attorney with Meissner Tierney Fisher & Nichols S.C., Milwaukee, where he practices in business law, estate planning, health care law, and intellectual property law.
Investing in a qualified Wisconsin business may provide certain tax benefits to individuals. Thomas Nichols and James DeCleene discuss these benefits and some potential pitfalls.
Wisconsin law currently provides tax-favored status to certain investments made in qualified Wisconsin businesses.
First, where an individual realizes long-term capital gain from the sale of an investment in a qualified Wisconsin business made after 2010 and held for 5 or more years, that individual may be entitled to exclude all or a part of that gain in determining his or her Wisconsin taxable income.1
Second, where an individual realizes long-term capital gain from the sale of any capital asset, that individual may be entitled to defer that gain so long as he or she invests all of the gain in a qualified Wisconsin business within 180 days of the sale.2
Qualified Wisconsin Businesses
Importantly, the registration filing must be made before the end of the calendar year when it takes effect.4 The sole exception to this deadline is that, for the first year in which an entity begins doing business in Wisconsin, that business must register in the following calendar year.5
Since each filing only covers one calendar year, businesses desiring continuous qualified status should file every year.6 These filing requirements create hard and fast deadlines. There are no procedures for retroactive filings.
Only certain businesses can register with the department as a qualified Wisconsin business. In particular, a business must, with respect to its taxable year ending immediately prior to its registration, meet the following requirements:
- The business must have had 2 or more full-time employees.
- 50 percent or more of the business’s payroll must have been paid in Wisconsin.
- 50 percent or more of the value of the business’s real and tangible personal property (owned or rented) must be located in Wisconsin.7
With respect to the year in which a business first starts doing business in Wisconsin, these requirements are deemed satisfied if the business registered for the following year.
For purposes of the two 50-percent requirements listed above, persons employed by a professional employer organization or group are considered as employed by the organization’s or group’s client, and property owned by the business is valued at its cost, while property rented by the business is valued by taking the annual rental paid by the business for such property, subtracting out the annual sub-rental received by the business for such property and multiplying by 8.8
Lists of the businesses that have requested to be classified as qualified Wisconsin businesses for calendar years 2011-18 can be found on the Department of Revenue website.
Businesses are automatically added to these lists as part of the registration process for a given year.9
Since a business’s registration for its first year is determined by reference to the following year, a business must request to be added to the list for the first year in which it does business in Wisconsin. This request is made by sending an email to DORISETechnicalServices@wisconsin.gov and providing the business’s legal name as well as the confirmation number for its registration for the following calendar year.
Be aware that these lists do not signal the department’s acknowledgement that a business is in fact a qualified Wisconsin business for a given year. Rather, it merely identifies those businesses that have self-identified as meeting the above requirements.
Accordingly, obtain representations, covenants, or other assurances as to a business’s qualified status when helping clients identify a qualified Wisconsin business in which to make an investment.
Exclusion on Sale of Investment
As noted above, one of the benefits of investing in a qualified Wisconsin business is that the long-term capital gain on the eventual sale of that investment may be wholly excluded.10
To qualify for this exclusion, the business must be a qualified Wisconsin business “for the year of investment” and “at least two of the four subsequent” calendar years, provided that the investment was made after 2010 and held for at least five uninterrupted years.11 To claim this exclusion, an individual must file a Schedule QI with his or her Wisconsin tax return.
There are a number of issues to be aware of in applying this provision. To start, this exclusion only applies after the sale of an “investment” in a qualified Wisconsin business.12 For these purposes, an investment is defined as an “amount paid to acquire stock or other ownership interest in a partnership, corporation, tax-option corporation, or limited liability company treated as a partnership or corporation.”13
While the statute requires an “amount [to be] paid” for such stock or ownership interest, we confirmed in a phone call with the Wisconsin Department of Revenue that this definition is broad enough to cover transactions involving noncash consideration. We also confirmed that the statute should also apply to cross-purchases where the ownership interest is being acquired from an owner of the entity, rather than from the entity itself. In order for an investment in a single member LLC to qualify, the LLC must have elected to be treated as an S or C corporation for Wisconsin purposes. 2017 Form I-177.
Be aware that late-year investments in entities that have not yet started doing business in Wisconsin may not be eligible for gain exclusion. For example, take the situation where an individual invested in an LLC in November 2017, but the LLC did not actually start doing business in Wisconsin until March 2018. Under those facts, the LLC would be prohibited from registering with the department as a qualified Wisconsin business for calendar year 2017 since it would not have started doing business in Wisconsin until 2018.14
Because of this, the business could not be qualified during the year of the investment, and no exclusion would apply on the eventual sale of the investment, even if the business registered as a qualified Wisconsin business for each calendar year in which it did business in Wisconsin.15 Thus, it’s good to advise clients whether to wait to invest in a business until the calendar year in which the entity starts doing business in Wisconsin.
Note that gain passed through to an individual from a partnership, limited liability company, limited liability partnership, tax-option corporation, trust or estate can qualify for the exclusion.16 As an example, an individual investing in a limited partnership that made an investment in an LLC would be able to exclude the gain passed through from the limited partnership’s sale of its interest in the LLC, provided that the limited partnership held the interest for five years and all other requirements are satisfied.
Deferral upon Rollover
Taxpayers may also be able to defer long-term capital gain so long as all of the gain is invested in a qualified Wisconsin business within 180 days of the sale of the capital asset.17 In addition to rolling the gain over into a qualified Wisconsin business, the individual must also file a Schedule CG with his or her tax return in order to claim this deferral.18 Note that this gain deferral provision is applicable to a large number of transactions, given that it could be used to defer any long-term capital gain.19
As with the gain exclusion provision above, there are a number of issues to be aware of when applying this deferral provision. For example, this deferral provision uses the same definition of “investment” noted above, so be aware that the investment in the qualified Wisconsin business for these purposes could also be made with noncash consideration or in a cross-purchase transaction.20
Additionally, the same problem with respect to late year investments in an entity that has not yet started doing business in Wisconsin is also applicable to this deferral provision. Further, gain passed through to an individual from a partnership, limited liability company, limited liability partnership, or tax-option corporation qualifies for deferral as well.21
For purposes of the deferral provision, however, it is unclear whether gain passed through from a trust or estate could be deferred since the instructions to Schedule CG are silent on this point. That being said, Form I-177, the instruction form for Schedule QI, allows for the exclusion of gain passed through from trusts and estates, and both the exclusion provision and the deferral provision have an identical definition of “claimant,” so it seems likely that an individual could defer gain passed through from such entities as well.22
On top of these overlapping issues, when advising a client with respect to the deferral provision, be careful to ensure that your client “invests all of the gain [from the sale] in a qualified Wisconsin business.”23 No partial deferral is allowed.
Also, given that this investment must be made within 180 days of the sale, apprise clients before the sale closing of this potential deferral opportunity and the relatively short deadline associated with it, in order to give clients time to make arrangements to acquire an interest in a qualified Wisconsin business.
Last, note that gain deferred under this provision will eventually be recognized. The statute accomplishes this by reducing the individual’s basis in the investment in the qualified Wisconsin business by the amount of gain deferred.24 Then, to prevent any slippage between the exclusion and deferral provisions, the statute prevents the deferred gain from being treated as qualifying gain for purposes of the gain exclusion provision.25
Note, however, that if the investment in the qualified Wisconsin business is held in a manner sufficient to qualify for the exclusion above, the gain on the eventual sale of the investment could qualify for exclusion to the extent it exceeds the gain previously deferred.
Investing in a qualified Wisconsin business provides clear benefits to individual taxpayers. If the investment is held long enough and all other requirements are met, the gain could be wholly excluded in determining the individual’s Wisconsin taxable income.
Additionally, if the investment closely follows the sale of a capital asset, the gain from that sale could be wholly deferred.
In either event, it’s good to bear these considerations in mind when navigating these provisions.
This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section web pages to learn more about the benefits of section membership.
3 Wis. Stat. §§ 71.05(25)(a)(1s), 73.03(69)(a).
4 Tax § 2.986(4)(a).
5 Tax § 2.986(4)(b).
6 Tax § 2.986(4)(a).