The following article by James N. Phillips appeared in the February 13, 2019 issue of the Business Law Section Blog of the State Bar of Wisconsin and is being reposted from that site with the permission of the author and the State Bar of Wisconsin.


Jim Phillips, Iowa 1979, is a shareholder in the Milwaukee office of Godfrey & Kahn, S.C., where he practices tax and corporate law.


Section 1202 of the amended Internal Revenue Code of 1986 allows exclude up to 100 percent of the gain on sale of stock held more than five years, if such stock meets the definition of “qualified small business stock.” Jim Phillips discusses some of the requirements and traps of Section 1202.

An owner of C corporation stock may be able to exclude up to 100 percent of the gain on sale of stock held more than five years, if such stock meets the definition of “qualified small business stock” (QSBS) under Section 1202 of the Internal Revenue Code of 1986, as amended.

The gain might also be excludable from Wisconsin tax if the corporation is a qualified Wisconsin business and the requirements of Wis. Stat. section 71.05(25)(b) are met.

Given the significantly lower federal income tax rate on C corporation income (21 percent) compared to the federal income tax rate on flow-through income of S corporations and LLCs (37 percent or 29.6 percent, depending on whether the 20 percent deduction of Section 199A applies), the availability of the Section 1202 exclusion can, in some cases, tip the scales toward C corporation status when evaluating the proper choice of entity.

Here is a summary of the requirements and traps of Section 1202.

Section 1202 Offers Partial or Total Exemption from Tax for Certain Capital Gains

Section 1202 exempts from tax a specified percentage of a taxpayer’s gains from the sale of QSBS provided the taxpayer held the QSBS for more than five years (among other requirements discussed below).

The applicable exemption percentage for stock acquired on or after Sept. 27, 2010, is 100 percent. For stock acquired earlier, the exemption may be 50 percent or 75 percent, depending on the taxpayer’s stock acquisition date.

Congress has repeatedly changed the amount of the Section 1202 exemption with varying effective dates. For stock for which the 100 percent exclusion applies, the excluded gain is not a preference under the alternative minimum tax (AMT).

For other exclusion percentages, a portion of the excluded amount is an AMT preference.

The table below summarizes the interaction of Section 1202, AMT, and other code provisions.

 

Date of Stock Acquisition § 1202 Tax Exemption Percentage § 1202 Capital Gain Rate Effective Capital Gains Rate Effective Net Investment Income Tax Rate Effective AMT Tax Rate AMT rate savings vs. 23.8% regular capital gain rate
On or after Aug. 11, 1993, but before Feb. 17, 2009 50% 28% 14% 1.9% 14.98% 6.92%
On or after Feb. 17, 2009, but before Sept. 27, 2010 75% 28% 7% 0.95% 8.47% 14.38%
On or after Sept. 27, 2010 100% 28% 0% 0% 0% 23.8%

For example, assume that individual X acquired $1 million of Y corporation stock in 2019, and Y stock is a capital asset in X’s hands. If the Y stock is not QSBS and X sells it in 2026 for $6 million, then X realizes a gain of $5 million. In that case, X could potentially owe federal income taxes of $1.19 million ($5 million gain x 23.8 percent capital gains rate).

However, if the Y stock were QSBS in X’s hands, then X’s entire Section 1202 gain on the sale would be excluded and X would owe no federal income taxes attributable to the sale. Thus, X would have tax savings of $1.19 million. This would be in addition to the lower C corporate income tax rate over the 6-year period. However, choice of entity is usually not just a current or future tax rate issue. A number of factors need to be considered: expected dividend distributions, the flexibility of structuring a potential future sale as an asset sale, estate planning considerations, etc.

Requirements for the Section 1202 Exemption

For stock in a corporation to qualify for the exemption in Section 1202(a), the following requirements must be satisfied:

  • Five year holding period – the taxpayer must have held the stock for at least five years.
  • Shareholder other than a corporation – the taxpayer claiming the Section 1202 exclusion must not be a corporation.
  • Acquisition at original issuance for cash or services – the taxpayer must have acquired the stock at its original issuance either (i) in exchange for money or other property (not including stock) or (ii) as compensation for services provided to the corporation. However, this requirement is waived in certain cases. For instance, if QSBS is transferred by gift or at death, the donee or heir, respectively, steps into the donor or decedent’s shoes for purposes of the Section1202 original issuance requirement and five year holding period.
  • Domestic C Corporation – the stock must be a corporation created or organized in the U.S. or any State that is taxed under subchapter C of the Code.
  • Gross Asset Test – The aggregate gross assets of the corporation prior to and immediately after the taxpayer acquires the stock must not exceed $50 million. For this purpose, aggregate gross assets includes the amount of cash and the combined adjusted bases of other property held by the corporation. However, the adjusted basis of any property contributed to the corporation is determined as if the basis of such contributed property were equal to its fair market value at the time of contribution.
  • Qualified Active Business – The corporation must have conducted a “qualified trade or business,” which is defined in the negative to exclude the following types of businesses:
    • any business involving performing services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any business where the principal asset of the business is the reputation or skill of its employee(s),
    • any banking, insurance, financing, leasing, investing, or similar business,
    • any farming business (including the business of raising or harvesting trees),
    • any business involving the production or extraction of products of a character with respect to which a deduction is allowable under section 613 or 613A, and
    • any business of operating a hotel, motel, restaurant, or similar business.

Additionally, the corporation must be an “eligible corporation,” which primarily excludes a regulated investment company, REIT, REMIC or cooperative.

  • 80 percent of assets by value used in a qualified active business – At least 80 percent of the corporation’s assets must have been used in the active conduct of one or more qualified trades or businesses during “substantially all” of the taxpayer’s holding period for the shares.

Common Situations that Prevent Stockholders from Taking Advantage of the Section 1202 Exclusion

Stock redemptions may cause all stock not to be QSBS

Given that the Section 1202 exclusion is designed to incentivize new business investment, the code has two provisions designed to prevent the exclusion from applying when newly issued stock is simply a replacement of a prior investment.

Stock is not QSBS if at any time during the four-year period beginning two years before the stock was issued, the issuing corporation purchases more than a de minimis amount of its stock from the taxpayer or a person related to the taxpayer. Redeemed stock exceeds a “de minimis amount” only if (i) the amount paid for it is more than $10,000 and (ii) more than 2 percent of the stock held by the taxpayer and related persons is acquired.

Under the second provision, stock is not QSBS, if during the two-year period beginning one year before the stock was issued, the corporation repurchased stock in one or more transactions (i) each of which involves a repurchase of more than $10,000 of stock where more than 2 percent of all outstanding stock by value is repurchased and (ii) the sum of all repurchases during the two-year period have a value, at the time of redemption, in excess of 5 percent of the aggregate value of all the corporation’s stock at the beginning of the two-year period.

Large rounds of venture capital financing may cause the corporation to fail the qualified active business test or the gross asset test

The qualified active business test requires that during “substantially all of the taxpayer’s holding period” at least 80 percent (by value) of the corporation’s assets must be used in active conduct of a one or more qualified trades or businesses. Subject to certain allowances for working capital and financing research and experimentation, this means that if more than 20 percent of a corporation’s assets become cash or other non-qualified assets immediately after a venture capital round of financing or at any other time, such corporation may fail this “substantially all” test.

Additionally, in order for stock to qualify as QSBS, the aggregate gross assets of the corporation cannot exceed $50 million at either (i) any time prior to the taxpayer’s stock acquisition date and (ii) immediately after the taxpayer’s stock acquisition date.

Contributions of appreciated property in exchange for stock are subject to further limits

For purposes of the requirement that a qualified small business have aggregate gross assets of $50 million or less, aggregate asset value is generally measured as cash plus the adjusted basis of the other assets. However, the basis of any property contributed to the corporation is deemed to be equal to its fair market value (FMV) for purposes of this gross asset test.

The contribution rule also affects a shareholder’s basis in his QSBS and the calculation of gain on later sale. When a shareholder has contributed property to a qualified small business, the shareholder’s basis in her QSBS is also deemed to be the FMV of the contributed property at the time of contribution, even though for all other tax purposes, the shareholder has carryover basis in her stock equal to her adjusted basis in the contributed property. Only future appreciation is eligible for the Section 1202 exclusion.

Stock must be acquired at original issuance to qualify for Section 1202

Generally, a shareholder must acquire stock at original issuance in exchange for cash or other property or as compensation for the stock to qualify as QSBS. A purchase from an existing shareholder will not qualify for the exclusion.

This strict rule is relaxed a bit, however, in the realm of corporate reorganizations. When a shareholder exchanges QSBS for other stock in a tax-free reorganization, such as a merger or stock for stock acquisition, the new stock received by such shareholder can qualify as QSBS with the holding period tacking. However, the exception only applies to the built-in gain in the stock at the time of the tax-free reorganization. Future gains in the stock received do not qualify for the Section 1202 exclusion, unless the new corporation is also a qualified small business.

​​​​​


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.


THOMAS J. NICHOLS & JAMES DECLEENE

Thomas J. Nichols, Marquette 1979, is a shareholder with Meissner Tierney Fisher & Nichols S.C., Milwaukee, where he focuses his practice on business law and tax law.

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

A business is treated as a qualified Wisconsin business for a given year only if it is registered with the Wisconsin Department of Revenue.3

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:

  1. The business must have had 2 or more full-time employees.
  2. 50 percent or more of the business’s payroll must have been paid in Wisconsin.
  3. 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.

Conclusion

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.

Endnotes

1 Wis. Stat. § 71.05(25)(b).

2 Wis. Stat. § 71.05(26)(bm)(1).

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).

7 Wis. Stat. § 73.03(69)(b)(1)-(2).

8 Wis. Stat. § 73.03(69)(b)(1); Tax § 2.986(3).

9 Wis. Stat. § 73.03(69)(d).

10 Wis. Stat. § 71.05(25)(b).

11 Wis. Stat. § 71.05(25)(a)(2).

12 Wis. Stat. § 71.05(25)(a)(2).

13 Wis. Stat. § 71.05(25)(a)(1m).

14 Tax § 2.986(2), (4)(b); see Wis. Stat. § 71.22(1r) (defining “[d]oing business in this state” for this purpose).

15 Wis. Stat. § 71.05(25)(a)(2).

16 Wis. Stat. § 71.05(25)(a)(1); see 2017 Form I-177 (listing trusts and estates as well).

17 Wis. Stat. § 71.05(26)(bm)(1).

18 Wis. Stat. § 71.05(26)(bm)(2).

19 Wis. Stat. § 71.05(26)(bm).

20 Compare Wis. Stat. § 71.05(26)(a)(2m), with Wis. Stat. § 71.05(25)(a)(1m).

21 Wis. Stat. § 71.05(26)(a)(1).

22 Compare Wis. Stat. § 71.05(26)(a)(1), with Wis. Stat. § 71.05(25)(a)(1); see 2017 Form I-177.

23 Wis. Stat. § 71.05(26)(bm)(1) (emphasis added).

24 Wis. Stat. § 71.05(26)(c).

25 Wis. Stat. § 71.05(26)(f).​

The EU’s new data privacy law, the General Data Protection Regulation, represents far-reaching changes that make it one of the strictest in the world. Randal Brotherhood discusses this new law and why U.S. businesses need to pay attention to it.


This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney Randal J. Brotherhood ,Washington University 1981, who is a shareholder in the Milwaukee law firm of Meissner Tierney Fisher & Nichols S.C., where he practices primarily in the areas of corporate law, representing both for-profit and tax-exempt entities, intellectual property, and securities law.


Virtually all U.S. businesses, nonprofit organizations, and other enterprises collect data from their customers or other individuals with whom they interact. All such enterprises should be aware of the European Union’s new General Data Protection Regulation, 2016/679, commonly known as the GDPR,1 which became effective on May 25, 2018.

The GDPR is a regulation under EU law pertaining to privacy and data protection for individuals within the EU and the European Economic Area. It is a sweeping legislative enactment generally considered to be the most far-reaching change in EU data protection law in many years, and possibly the strictest privacy law in the world.

The GDPR also governs the export of personal data outside the EU, and applies to parties – regardless of location – that collect personal data of individuals within the EU.

Because of this, businesses and other enterprises worldwide, and particularly in the U.S., have devoted considerable attention and resources to complying with the GDPR by the May 25 deadline, and still others are continuing to grapple with its requirements.

Applies Outside EU

The primary objective of the GDPR is to enhance the control individuals within the EU have over their personal data, and to simplify the regulatory environment for data collectors as to data privacy by establishing a single set of data privacy rules that apply throughout Europe.

It is noteworthy, however, that the GDPR has important implications for businesses and other enterprises well beyond the EU/EEA. This includes businesses in the United States, in that its provisions apply to enterprises located in the EU that process data of individuals residing in the EU, as well as any enterprise, regardless of location, that holds or processes personal data of an EU resident.2

Accordingly, any U.S. business that has individual EU customers or otherwise holds or processes transactions or data for individuals within the EU are subject to the GDPR’s requirements and its rigorous enforcement provisions.

Express Consent Required

For many businesses, the GDPR will change how data collectors approach the notion of data security, as evidenced by its requirement that an EU individual’s data, first, be stored only on systems designed and developed with a specific view toward data protection and, second, that such systems employ privacy settings set by default at the highest possible level of protection (these concepts being referred to in the GDPR as data protection “by design” and “by default,” respectively).3

The underlying notion is that an individual’s data are not to be publicly available (and cannot be used to identify the subject absent additional, separately stored information) without the express, opt-in consent of the individual data subject.4

Unless the individual has provided such express consent (rather than just a tacit failure to object) to the processing of his or her data for one or more specifically-stated purposes, the individual’s data may not be processed unless there is a specified legal basis for such processing and the purpose(s) of such data processing is disclosed to the individual.5 The data collector must be able to prove that it obtained such express consent from the data subject, who may revoke such consent at any time.6

Key GDPR Concepts

Although an exhaustive explanation of the GDPR is beyond the scope of this post, the following is a summary of some of its key concepts.

The GDPR Applies to Personal Data
The GDPR applies to the processing of “personal data” or any information relating to an “identifiable natural person”7 – that is, an individual who can be identified, directly or indirectly, by reference not just to common identifiers such as name, home address, telephone number, a photograph, or an email address, but also by less obvious identifiers such as bank or medical information, social networking posts, IP addresses, or any other data pertaining to location or to the physical, physiological, genetic, mental, economic, cultural, or social identity of such individual.8

These identifiers are considered to be personal data even if on their face they do not identify an individual, as long as they can be (or are capable of being) traced back to the subject individual without undue effort. It does not matter whether the individual’s personal data pertains to his or her personal or work-related capacities; if the data falls within the scope of “personal data,” regardless of whether it is personal, work-related or otherwise – it is subject to GDPR regulation.

It should be noted, however, that the GDPR does not apply to processing data “for a purely personal or household activity and thus with no connection to a professional or commercial activity.”9

Controllers and Processors
The GDPR directs most of its requirements toward “data controllers” (businesses or organizations the collect the data) and “data processors” (organizations that process data on behalf of a data controller, such as a third-party software or other service that a business may use to process data on its behalf).10

Data controllers are required under the GDPR to utilize only those data processors that provide sufficient assurances that they will implement appropriate technical and organizational measures to meet the GDPR’s requirements and protect the rights of individual data subjects.11

Privacy Management
Both data controllers and data processors are required to implement programs to assure compliance and be able to demonstrate such compliance to data subjects and regulatory authorities.12

Overall, the GDPR calls for a risk-based approach, that is, the utilization of controls which correspond to the degree of risk associated with the data processing activities. To this end, businesses that are data controllers must, for instance, put in place procedures to prevent data from being processed unless necessary for a specified purpose.13

Further, such businesses must incorporate technological and organizational measures appropriate to the nature of the business to ensure the protection of individuals’ personal data,14 including:

  • pseudonymization and/or encryption of data so that it cannot be attributed to individual without use of additional information;
  • restoring the availability of data in a timely manner in the event of a loss of data; and
  • regularly testing and evaluating the effectiveness of security measures.

Data controllers must maintain records of their processing activities, although there is an exclusion for small businesses (less than 250 employees) where data processing is not a significant risk.15

Additionally, controller/processor relationships must be documented and managed with contracts that specifically set forth the parties’ privacy and data protection obligations.

Data Protection Officers
Businesses that are data controllers or data processers are required under the GDPR to appoint a “data protection officer” if their essential activities involve, on a large-scale, regular monitoring of personal data or processing of sensitive data.16

A data protection officer must have IT processing, data security, and business continuity competence in personal data processing.

Lawful Basis for Processing of Personal Data
Unless a subject individual has provided express, affirmative consent to the processing of his or her personal data for one or more stated purposes, such data may not be processed unless there is at least one specified legal basis to do so.17

If the individual’s consent has not been obtained, the subject’s personal data may be processed only:

  • to comply with a legal obligation;
  • to perform a contract with the data subject;
  • to protect vital interests of the data subject when he or she is unable to give consent;
  • for the performance of a task carried out in the public interest or the exercise of official authority; or
  • for the purposes of legitimate interests of the data controller or a third party (but subject to certain fundamental rights and freedoms).18

Consent
If the data subject’s consent is the basis for the processing of his or her data, such consent must consist of:

 

“any freely given, specific, informed and unambiguous indication of his or her wishes by which the data subject, either by a statement or by a clear affirmative action, signifies agreement to personal data relating to him or her.”19

That is, such consent must be explicit for the data collected and for each purpose that the data are used, so that the controller can clearly show when and how the consent was obtained.

Accordingly, the purpose(s) for the individual’s data will be collected and used must be clearly and expressly disclosed to the data subject so that it is obvious what the data are going to be used for.

Consent must be demonstrable and freely given. A controller cannot require the disclosure of data as a prerequisite or condition of, for instance, the provision of services or the performance of a contract.20

Additionally, the data subject must be allowed to revoke consent in a manner no more burdensome than the manner in which consent was given.21

Information Provided at Data Collection
Individual data subjects have enhanced rights under the GDPR to access and obtain copies their data, as well as rights to require rectification or erasure of their personal data, to restrict further processing, and to lodge a complaint with a supervisory authority.22

Individuals must be informed of these rights and, in addition they must be given information about how their data will be processed.23

Breach and Notification
In the event a breach of security of an individual’s data in the hands of a data controller which gives rise to the destruction, loss, or unauthorized disclosure of such individual’s data, the data controller must notify the appropriate supervisory authority “without undue delay,” and “where feasible,” within 72 hours after having become aware of such breach.24 If such notification is not made within 72 hours, the data controller must provide a “reasoned justification” for the delay.25

Such notice is not required if the data breach is “unlikely to result in a risk for the rights and freedoms” of subject individuals,26 although how this exception is to be interpreted will likely require future clarification.

If the data controller determines that a personal data breach “is likely to result in a high risk to the rights and freedoms” of subject individuals, it must – subject to certain exceptions – also notify the individuals affected by the data breach “without undue delay.”27

In the event of a data breach by a data processor, it must notify the data controller,28 but the GDPR does not otherwise impose any other notification or reporting obligation on the data processer.

Fines and Enforcement
Businesses should note that, for GDPR violations, the GDPR provides for liability, including fines, for both data controllers and data processors as well as remedies for data subjects.

Regulators may impose penalties equal to the greater of €10 million or 2 percent of the violator’s worldwide revenue, for violations of record-keeping, security, and breach notification requirements.29

Violations of obligations related to legal basis for processing, consent requirements, data subject rights, and cross-border data transfers are subject to penalties up to the greater of €20 million or 4 percent of the violator’s worldwide revenue.30 EU member states may impose additional penalties, which may include criminal penalties.31

Data subjects have the right to make complaints with “data protection authorities” maintained by EU member states, as well as to initiate judicial proceedings.32

Additionally, data controllers and processors can be held responsible to compensate affected data subjects for damages resulting from a GDPR violation.33

Considerations and Recommendations

Although many U.S. businesses may be tempted to disregard the GDPR as a non-U.S. regulation relevant only to large multinational corporations, this approach could do great harm to such enterprise if it has European customers or otherwise collects data from European individuals.

No matter the size or nature of the business, if it collects any kind of personal data on EU residents, it is very likely subject to the GDPR and its requirements.

Given the substantial monetary and other penalties for noncompliance, businesses of all sizes should clearly understand whether and how the GDPR applies to them, and establish a game plan for GDPR compliance as necessary.

Establishing a Game Plan for GDPR Compliance

Businesses and their legal advisers should start by assessing the extent to which they have EU customers and/or collect data from EU residents, and acknowledging that they may have to alter current data handling procedures in light of the GDPR.

This assessment should include a review of the types of personal data the business collects and holds, what the data are used for, and whether the business is collecting more information than is reasonably necessary for its legitimate business purposes.

Further, businesses should assess the documents (whether in written or electronic format) they require customers to sign when purchasing or obtaining products or services. It is likely that such documents may need revision in light of GDPR requirements, to ensure that customers know how the business is processing their data and why. This may include development and implementation of new processes for obtaining and verifying express (rather than tacit) customer consent to data collection, and for the transfer and deletion of such data when requested.

Given the GDPR’s reach well beyond the boundaries of the European Union, and the substantial fines and other sanctions that can arise for GDPR violations, businesses and other enterprises collecting data from EU residents are well advised to have a clear understanding of the GDPR and its applicability to their operations.

For more information on the GDPR, see Keith Byron Daniels’s article, New European Privacy Law: Its Effect on Wisconsin Lawyers, in the July/August 2018 issue of Wisconsin Lawyer magazine.

Endnotes

1The GDPR is formally known as “Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC (General Data Protection Regulation).”

2 GDPR, Article 3(3).

3 GDPR, Article 25 (Data protection by design and default).

4 GDPR, Article 6(1)(a).

5 GDPR, Article 6(1)(b)-(f).

6 GDPR, Article 7(3).

7 GDPR, Article (4)(1).

8 GDPR, Article 4(1).

9 GDPR, Article 2(2)(c).

10 GDPR, Article 24 (Responsibility of the controller) and Article 28 (Processor).

11 GDPR, Article 24(1).

12 GDPR, Articles 24, 28.

13 GDPR, Article 24(1).

14 GDPR, Article 24 (Responsibility of the Controller; Article 40 (Codes of Conduct).

15 GDPR, Article 30(1), (5).

16 GDPR, Article 37 (Designation of the data protection officer).

17 GDPR, Article 6 (Lawfulness of processing).

18 See Footnote 5, above.

19 GDPR, Article 4(11).

20 GDPR, Article 7 (Conditions for consent).

21 GDPR, Article 7(3).

22 GDPR, Article 15 (Right of access by the data subject).

23 GDPR, Article 7(2).

24 GDPR, 33(1); GDBR, Recital 85 (Notification obligation of breaches to the supervisory authority).

25 GDPR, Article 33(2).

26 GDPR, Article 33(1).

27 GDPR, Article 34(1) and (3); GDPR, Recital 86.

28 GDPR, Article 33(2).

29 GDPR, Article 83(4).

30 GDPR, Article 83(5).

31 GDPR Article 84 (Penalties); GDPR, Recital 149 (Penalties for infringements of national rules).

32 GDPR, Article 77(1).

33 GDPR, Article 82 (Right to compensation and liability).

​​

 

This article was originally posted on the “State Bar of Wisconsin’s Business Law Section Blog,” and was written by Attorney James Phillips.

 

The passage of the Tax Cuts and Jobs Act brings significant changes to the structure, financing, and agreements in mergers and acquisitions transactions. James Phillips details the more noteworthy provisions that apply in 2018 and beyond.

At the end of 2017, President Trump signed into law the Tax Cuts and Job Act (Act), with many provisions effective for tax years beginning after Dec. 31, 2017.

The Act contains a number of changes that may affect the structure, financing, and agreements related to mergers and acquisitions (M&A) transactions.

Here is a summary of the more significant provisions:

Tax Rate and Certain Deduction Changes

  • Corporate Rates. The Act changes the federal income tax rate applicable to C corporations to a flat rate of 21 percent (down from a maximum of 35 percent).
  • Individual Rates. The Act changes the maximum individual income tax rate on ordinary income from 39.6 percent to 37 percent. The maximum income tax rate on long-term capital gain and qualified dividends remains unchanged at 20 percent and the net investment income tax rate remains unchanged at 3.8 percent. The Section 1202 exclusion of 100 percent of the gain on the sale of qualified small business stock (among other requirements, C corporation stock) held for more than five years remains unchanged.
  • Individual Deductions. Itemized deductions for state and local taxes for individuals are now limited to $10,000 in combined income and property taxes for tax years 2018 through 2025, provided that the deduction for state and local taxes incurred in carrying on a trade or business or for the production of income is retained (such as business taxes imposed on pass-through entities and taxes on Schedules C and E).
  • Pass-through Business Rate. The Act provides for a deduction of up to 20 percent of “qualified business income” earned through partnerships, S corporations and sole proprietorships (including single member LLCs). There are a number of special rules and limitations. This deduction is not available for capital gains, dividends and interest (other than interest allocable to a trade or business). Owners of certain service businesses are subject to phase out rules, and the deduction can be limited to a percentage of wages and depreciable property. This deduction can result in an effective marginal income tax rate of 29.6 percent on qualifying income (plus the 3.8 percent net investment income tax [NII] if applicable).
  • Choice of Entity. The new, lower corporate income tax rate will require more analysis of the preferable way to conduct business operations and structures transactions. The lower corporate rate permits businesses to grow their equity and pay down debt at a faster rate. In many circumstances the ability to avoid the higher shareholder rate applicable to a pass-through, the benefit of shareholders not being involved in corporate tax planning and compliance, the ability to capture net operating losses at the corporate level for carryforward, the potential for the 1202 capital gain exclusion upon a stock sale, the new foreign tax regime, the decrease in the value of a step up in asset basis upon a sale due to the lower corporate income tax rate, the deductibility of state taxes, and others, will make C corporations more desirable. On the other hand, if a business is likely to produce sizable cash distributions to the owners on a current basis, or a sale is likely to be structured for tax purposes as an asset sale (whether asset purchase, forward merger or sections 336 or 338 elections) in the not too distant future, pass-through structures may continue to be preferable, although potentially more costly in the short run.
  • Blocker Entities. The new lower corporate income tax rate may make blocker entities much more common in a variety of situations.
  • Valuation. The change in the income tax rates could result in a change in the value of a variety of assets, but how it will affect transactions is unclear. Some changes could increase value (larger after-tax cash flow due to lower rates) but some changes could decrease value (a reduction in value of tax assets). For example, the value of a step up in basis upon a transaction structured as an asset purchase for tax purposes is worth less with lower income tax rates.

Interest Deduction Limitations

In general, net business interest expense deductions will be limited to 30 percent of “adjusted taxable income,” plus business interest income. The annual tax increment (ATI) is initially related to earnings before interest, taxes, depreciation, and amortization (EBIDTA), but after 2022 will more closely relate to earnings before interest and taxes (EBIT). The amount of interest not allowed as a deduction for a year is treated as paid in the succeeding year, subject to that year’s limitation.

  • Exceptions. The interest expense limitation does not apply in certain cases, including taxpayers whose average annual gross receipts for the three-tax-year period ending with the prior tax period do not exceed $25 million, and electing real estate activities for which the taxpayer must then use a longer depreciation life.
  • Debt versus Equity. The lower corporate rate tax benefit of interest deductions, combined with the potential for deferral of interest deductions and the more favorable individual income tax rate for dividends, is designed to decrease the benefit of debt compared to equity, and in certain cases may lead to less leverage.

Corporate Alternative Minimum Tax and Net Operating Losses

The Act repeals the corporate alternative minimum tax (AMT), but puts in place new limitations on net operating losses (NOLs). The Act eliminates NOL carrybacks but allows indefinite carryforwards. NOL deductions can only offset up to 80 percent of taxable income. The inability to carry back a loss means NOLs arising from a transaction, such as extraordinary compensation payments or other transaction-related items, can no longer be carried back to produce a tax benefit for the seller. And the inability to carry back a loss of a target company to offset pre-closing tax liabilities may change the structure of tax indemnities.

Full Expensing of Certain Property

The Act provides for a deduction of the entire cost of certain property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Thereafter, the percentage immediately deductible is phased down over five years. The Act applies to not only new tangible personal property, but also used property and computer software.

  • Thus, a purchaser in acquisition structured as an asset sale for tax purposes could purchase tangible personal property at its tax basis and immediate expense the cost rather than step into the shoes of the seller and inherit the depreciation deductions that would otherwise could have been spread over seven years.
  • While asset-treatment acquisitions will still most likely be driven by purchase prices in excess of tax basis giving rise to increased intangible amortization and fixed asset depreciation, the ability to accelerate the cost of used property due to 100 percent expensing will produce some new and interesting negotiations for sellers and purchasers. The interplay of the 100 percent expensing and NOL and interest limitations for the purchaser, and recapture and tax cost for the seller, will require careful modelling of transactions.

Sale of US Partnership Interest by Foreign Partner

A foreign person’s gain on sales after Nov. 27, 2017, of interests in a partnership engaged in a U.S. trade or business will be taxed as effectively connected income up to the extent a sale of assets would have been so treated, requiring the selling partner to pay U.S. tax on the sale.

Sales of such partnership interests after Dec. 31, 2017, will be subject to withholding unless the seller provides an affidavit stating that the seller is a U.S. citizen. If the purchaser fails to withhold, the partnership is required to withhold from the transferee’s distributions the amount the transferee should have withheld.

  • The IRS has delayed the effective date for the withholding for administrative reasons for publicly-traded partnerships. The IRS has requested comments on the rules to be issued under the withholding requirement to, among other things, determine how liabilities of the partnership affect the amount realized.
  • Much like Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) certificates in the case of the sale of U.S. real property or U.S. real property holding corporations, affidavits will likely become the norm in a sale of a partnership interest.

International Taxation

There are significant changes to the taxation of international activity that will require taking a new look at the structure of domestic and foreign operations.

In many cases taxes on international operations can be lower if the U.S. owner is a C corporation. M&A transactions often present an opportunity to reorganize international operations in a more tax efficient manner.

Note: The foregoing is a summary and is not tax advice directed at any particular situation. The specific statutory provisions and tax advisors should be consulted before taking any particular action.

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.

 

James Phillips, University of Iowa College of Law 1979, is a shareholder with Godfrey and Kahn in Milwaukee where he practices in the areas of domestic and international tax structuring, planning and controversy matters, corporate and business law, acquisitions and venture capital.



We do a lot of non-profit work. Oftentimes, we are working with new startups that are driven by strong social motivation, but to form and survive need investment capital. This puts us at a crossroad: do we go non-profit and non-stock or conventional corporation? Now, Wisconsin, joining 33 other states, has another alternative: the Benefit Corporation.

Non-profit corporations must have certain characteristics in order to qualify as exempt entities under section 501(c) of the Internal Revenue Code. Charitable organizations qualify under 501(c)(3). Such qualification requires a charitable “purpose” and further requires that in no case may the corporation dissolve and distribute anything to its members or board, but instead, must go to another similarly organized entity. It also allow its donors to deduct contributions to the organization. Its income is not taxed.

If an entity is motivated to protect investor’s capital, make a return on such capital and distribute proceeds upon dissolution to its owners, then it is a “for profit” entity. As such, its income is taxed.

In the past, such entities could not “crossover.” They were one or the other. With the enactment of Chapter 204 of the Wisconsin Statures, on November 27, 2017, Wisconsin now allows corporations to be profit driven and to exist to promote one or more public purposes.

Why is this so important? Because, in the past, the directors of a non-profit had no owners to be responsible to. They promulgated the non-profit’s purpose, regardless of its impact upon the bottom line. Directors of profit corporations owed a fiduciary obligation to the owners to act in their best interests — which oftentimes meant they had to act primarily in consideration of what their actions would do to the bottom line. In addition, for-profit directors could consider three other factors in their decision making:

  • the effect upon employees
  • the impact upon customers
  • how their actions would be perceived by the communities within which they served

Under new Chapter 204, benefit corporation directors may now consider the following additional factors:

  • the effect upon subsidiaries and suppliers
  • any impact upon the local or global environment
  • the interests of customers as beneficiaries of the corporation’s benefit purposes
  • the short term and long term interests of the corporation
  • the ability and extent to which it may accomplish the corporation’s benefit purposes
  • other factors the directors or officers deem important

Note how the last item is a huge “catch all!”

So, what are these “public benefits” that the new benefit corporation must espouse? “A benefit corporation shall have a purpose of creating general public benefit.” Sec. 204.201(1) Wis. Stats. A “General public benefit” is “a material positive impact on society and the environment by the operation of a benefit corporation taken as a whole, through activities that promote some combination of specific public benefits.” Sec 204.120(5) Wis. Stats. Under that section’s subsection (7), “Specific public benefits” are:

  • (a) Providing low-income or under-served individuals or communities with beneficial products or services.
  • (b) Promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business.
  • (c) Preserving the environment.
  • (d) Improving human health.
  • (e) Promoting the arts, sciences, or advancement of knowledge.
  • (f) Increasing the flow of capital to entities with a public benefit purpose.
  • (g) The accomplishment of any other particular benefit for society or the environment.

The owners may sue directors who fail to consider the corporation’s benefit purposes. Directors are broadly protected if they do. Sec. 204.301(3) Wis. Stats. There shall be a designated “benefit director” who shall have the powers to carry out the statute’s intent. Sec. 204.302 Wis. Stats. The law promotes transparency, inasmuch as the corporation has to provide its shareholders an annual statement that includes:

  • objectives to promote public benefits, as set by the board
  • standards the board adopted to measure progress
  • factual information regarding the success of meeting objectives
  • an assessment regarding the success of meeting objectives

The articles or bylaws may extend such transparency by making such statement available to the public. Sec. 204.401 Wis. Stats.

While the concept of a benefit corporation is quite new, it may be the right form to do business for owners who are motivated to solve social or environmental issues. It assures such owners continued control in order to achieve such goals. Such goals may be used to promote the corporation and may be seen by others dealing with the corporation as a consideration when doing so. Employees may be drawn by such purpose; customers may choose to buy from such a company; communities may be proud to bring such operations into their midst; and owners may benefit by improving the world and making a profit at the same time!

If you, or any group you work with is interested in exploring this new form within which you may do business, please contact our business law experts at Schober Schober & Mitchell, S.C. at (262)785-1820.

Other reading:

If you’ve decided to create a startup business, one of the many decisions you face is the choice of what type of limited liability entity to form. In Wisconsin, the most typical choices are either the Limited Liability Company (“LLC”) or corporation. I frequently have people ask me whether I can help them set up an LLC for their business, and who often think, for whatever reason, that the LLC is their only option. My first response is always, “Is there a specific reason why you want to be an LLC?” and go on to explain that while there are some specific exceptions to this rule, a corporation is almost always the best type of limited liability entity for a startup small business compared to the LLC.

Why the Corporation is a Better Option

More Developed Law. In Wisconsin, the LLC has only been around since 1991, while the corporation has been around since 1848. Why is this relevant? There’s almost 160 years of law on corporations in Wisconsin, while there’s only 26 years of law on the LLC. This means there’s more settled law on issues with corporations and much more uncertainty within the law of LLCs. Where there are legal issues coming up in relation to your business, wouldn’t you rather have more certainty from years of developed corporate law than venture into the relatively undeveloped realm of LLC law?

Tax Considerations. Some argue that the LLC is preferable because it offers pass-through taxation to its members, meaning all income and loss the business has in a given year is spread according to the members’ equity stake in the business. You can easily elect for S-Corp status with the IRS to avoid the dreaded “double taxation” of C-Corporations and still get the same pass-through tax treatment given to LLCs. Corporations that elect S-Corporation treatment do have specific guidelines in regard to the number of owners, and the types of owners, but generally, those are irrelevant to most startups and small businesses. Since electing S-Corporation status allows for the same pass-through tax treatment for corporations, this puts the LLC and the Corporation on a level playing field.

Another huge tax benefit of the S-Corporation election is that, as an owner of the business, you only pay self-employment tax on the income that is attributable to the fair market value of your services provided to the business. If you are an LLC without a S-Corp election, you are taxed under Subchapter K of the Internal Revenue Code, and then must pay self-employment tax on all income allocated to you, no matter whether that income is attributable to your services as employee or not. For most small startup businesses, the owner also provides services as if she were an employee of the business, meaning that the employee/owner has to pay a self-employment tax on any income allocated to that individual in addition to income tax. In 2017, the self-employment tax is 15.3%.

In an LLC with no S-Corp election, no matter whether that allocated income is actually attributable to the services provided by the owner/employee, or whether that LLC level income is allocable to services provided by the employee owner and an employee non-owner, the owner pays all of the self-employment tax, AND income tax on top of that. For example, if an LLC had $100K of income that was allocated to the owner, the owner would pay the 15.3% self-employment tax as well as income tax on that amount, even if the owner only provided $50K worth of services as an employee of the LLC.

If the company had elected to be an S-Corporation, the employee/owner would only pay self-employment tax on the amount of income on the $50K attributable to her services as an employee/owner, and the remaining amount could be a tax-free “S-Corp” distribution that merely reduces the owner’s basis in corporation’s stock. This is a huge tax advantage, potentially saving thousands of dollars a year for S-Corp shareholders. Electing S-Corp is generally a good idea if your startup has employees or multiple owners, but you should always consult with a licensed CPA regarding whether this election would be beneficial to your particular business situation before doing so.

Investment Considerations. Finally, if you’re ever looking for equity investors like angel investors or venture capital groups, they generally prefer investing in corporations over LLCs. This is because, angels and VCs don’t want the extra income allocated to them for their share of profits from a pass-through tax structure at their higher tax rates, and prefer that their return on investment is paid through dividends (currently taxed at lower tax rates than ordinary income). When your business gets to the stage of looking for outside investment, depending on what your investors want, if you’ve elected S-Corp, you may want to revoke that S-Corp election to allow your investors to get the lower dividend rate, which is much easier than converting from an LLC to Corporation. Hopefully though, by that point in your business, you’re successful enough that the corporate level tax won’t be detrimental!

The Bottom Line

While there are situations where the LLC may be preferable for your particular business situation (which I’ll discuss in my next post), the corporate form is often still the better choice for most startups and small businesses . Choosing the type of entity now may seem like an insignificant decision now, but it may have a large impact on your business down the road. It’s best to consult with your legal professional to help you make the right choices when setting up a limited liability entity for your business. If you’re a startup that has already formed a limited liability entity or are thinking about starting a business and have questions about which type of entity to choose, email me at jmk@schoberlaw.com or call me at 262-569-8300 to set up an appointment to discuss your options.

A Federal Appeals Court ruled earlier this month that an S-Corporation’s rental income from a leairs[1]se agreement with a C-Corporation with entirely common ownership with the S-Corp, could not be classified as passive activity income, and therefore could not offset the individual’s passive activity losses.

Internal Revenue Code section 469 was passed in the 1980s to close a tax code loophole that allowed investors to invest in real estate ventures that were likely to incur heavy losses in order to offset an individual’s income. The section requires that for trades or businesses in which an individual does not materially participate, the income or loss from that activity must be classified as “passive” and therefore can only be offset against income or loss from other “passive activities.” The section specifically lists individuals, estates, trusts, closely held C corporations, and personal service corporations as taxpayers that are subject to the passive activity re-characterization rule. The section does not, however, list S-Corporations as a taxpayer that is subject to this rule.

Where an individual has losses from passive activities in a particular year, the individual can only offset that against passive income, or else be forced to roll over the losses into future years in which the individual has passive income. Some individuals had attempted to “create” passive income by engaging in what is known as “self-renting.” Self-renting occurs where a business owner creates another legal entity that the owner also owns, transfers title of business real estate to that entity, and then leases back the business real estate to the originally owned business. This way, there is rental income, (which is always classified as passive) that passes through to the individual, who can then offset her passive losses with that passive income. The IRS prohibited this practice in one of its regulations, stating that where this type of arrangement is present, the rents are then changed back from passive income, to non-passive income, thereby disallowing the offset against passive losses.

While the self-renting practice has been prohibited in the IRS regulations since the enactment of section 469, there has been no binding judicial authority that has ruled that the rule applies where an S-Corporation is the taxpayer receiving the rental income. The IRS has released some memos on the subject, which only evidence the opinion of the IRS, and not the binding interpretation of a neutral judge. In Williams v. CIR, the taxpayers were owners of both a C-Corporation, the lessee, and an S-Corporation, the lessor. They argued that because S-Corporations are not listed as taxpayers subject to section 469, and because S-Corporations do not pay taxes as an entity, the self-renting rule did not apply. The Fifth Circuit Court of Appeals rejected that argument and upheld an additional IRS regulation that stated that S-Corporations are subject to all section 469 rules (including the self-renting rule). This rule gives significant weight to the self-rental rule as it relates to S-Corporations, and all other pass-through entities (LLC and Partnerships).

Schober Schober and Mitchell stays apprised of updates and changes in tax laws as they relate to you and your business. Please contact us for advice on the tax status of your business or structure and for any of your other business needs.

This article was contributed by Jeremy Klang, a third year law student at Marquette University Law School and law clerk for Thomas Schober.

It’s too bad the United States Supreme Court didn’t issue its ruling in Comptroller v. Wynne in time for the 2014 tax season. In early May 2015, the nation’s highest Court ruled in favor of a couple in Maryland who argued that part of Maryland’s state tax regime was unconstitutional because it failed to give them a tax credit for taxes paid on income in another state’s county, municipality, or other local taxing authority. The couple, the Wynne’s, are Maryland residents that held stock in an S-Corporation which had gained income in other U.S. states in the taxable year, and they had paid state level and sub-state level taxes on that out-of-state income in states other than Maryland. Maryland’s tax code requires the Wynne’s to pay income tax on that out-of-state income to the state of Maryland in addition to the tax paid on that income in other states, resulting in a double tax on that income. While Maryland allows individuals a tax credit for taxes paid to the state-level taxing authority in other states, it does not allow individuals a tax credit for payment of taxes to out-of-state municipal, county, or other local taxing authority lower than the state level. In Wynne, the United States Supreme Court held that Maryland’s disallowance of a credit for an individual’s payment of tax to an out-of-state county, municipality, or other sub-state level taxing authority violates the dormant Commerce Clause because the disallowance provides those individuals who only engage in commerce within a particular state with an advantage, while it burdens those residents who engage in interstate commerce with a double tax.

Maryland is one of the few remaining states that have such a tax regime, but among these few remaining states is Wisconsin, which has an identical stance that allows tax credits for individuals who pay taxes to state level tax authorities but disallows credits for payment on out-of-state income to any sub-state level taxing authority. See Tax Publication 125, (January 2015), page 2, ¶ D. While most municipalities, counties, or other taxing authorities, such as school districts, at least in Wisconsin, derive much of their tax revenue from sales taxes and property taxes, many sub-state level taxing authorities outside Wisconsin impose income taxes in addition to the state level income tax. For example, about 80% of Iowa school districts impose a surtax that requires individuals to pay additional tax to a local school district on income earned in Iowa for a taxable year. These school districts are allowed to tax as much as 20% of the Iowa state income tax required to be paid to the state in the taxable year. Many other nearby states such as Michigan, Indiana, Ohio, and several other U.S. states also have some type of sub-state level income tax. For all those Wisconsin residents doing business or working with the jurisdiction of out-of-state taxing authority, under current Wisconsin law, you must pay an income tax both to Wisconsin and to the out-of-state sub-level taxing authority, but cannot receive any credit in Wisconsin for the payment to the out-of-state sub-state level taxing authority.

In light of this Wynne ruling, it remains to be seen whether the Wisconsin Department of Revenue will change their stance to allow tax credits for out-of-state payments. With the Wisconsin law and the Maryland law being virtually identical, there isn’t much wiggle room for Wisconsin to continue to disallow these credits. Though the Wisconsin law has not be expressly ruled unconstitutional by the Supreme Court like the Maryland law was in this case, it’d be surprising if the Wisconsin Department of Revenue didn’t to join the vast majority of states that allow a credit across the board for out-of-state income tax payments to sub-state level taxing authorities. However, if the Department of Revenue continues to disallow these credits for the 2015 tax year, it would be doing so in spite of controlling precedent from the nation’s highest Court.

Schober Schober & Mitchell will stay tuned to any changes on the Wisconsin Department of Revenue’s stance on this issue.

This article is the combined effort of Thomas Schober and our law clerk, Jeremy Klang.

Good news for those of you starting new exempt organizations: the IRS just released a new form, called the 1023-EZ, which will make applying for tax-exempt status for some smaller organizations much easier.  The new form is only three pages long, compared to the lengthy 26 page standard 1023 form.  The simplified form will substantially reduce the legal expense of starting a 501(c)(3) and hopefully speed up the IRS approval process.

The IRS hopes that simplifying the approval process for smaller organizations will also reduce delays for larger organizations by freeing up more resources to review the lengthier applications.  Currently, the IRS has more than 60,000 501(c)(3) applications in its backlog, with many of them pending for nine months or longer.

The IRS estimates that as many as 70 percent of all applicants will qualify to use the new 1023-EZ.  Most organizations with gross receipts of $50,000 or less and assets of $250,000 or less are eligible.

However, the new application processes is still not without complications.  For example, you will still have to decide whether your organization will be a public charity or private foundation.  Further, certain types of organizations, such as churches, are categorically excluded from using the new form, even if they are small in size.

Therefore, it is still important that you confer with an attorney who can help determine if you qualify to use the 1023-EZ and to help you make other important decisions related to your non-profit organization.  If you need assistance in this area, one of our business attorneys would be happy to assist you.

Thanks to our law clerk, Kelsey O’Gorman, who assisted in the post.

How is Washington going to raise legal fees? Quite simple: just raise the costs for lawyers to do business by raising taxes substantially on many law firms.

The Federal Government has two bills pending, each of which would require law firms with gross receipts in excess of $1 Million to report for tax purposes using the accrual method of accounting. Most such law firms currently report on a cash basis. Consequently, if passed, all such law firms would have to report as taxable income monies which were billed, but not yet received. That would have the effect of causing a large amount of taxes to be paid by all such firms, which essentially means that in order to continue to meet all their other expenses, including payroll, such firms would be left with one option: raise fees.

If you may be opposed to such action, please consider writing your Senators and Representatives, mentioning the Tax Reform Act of 2014 and Section 51 of a similar Senate draft bill.