Tax 3.01(4)(e)3.a. a. If the related entity expense was paid, accrued, or incurred to a pass-through entity, any tax rate that is imposed at the shareholder, partner, member, or beneficiary level rather than at the pass-through entity level for that state, U.S. possession, or foreign country.

Tax 3.01(4)(e)3.b. b. If the related entity is a pass-through entity, only taxes imposed at the entity level that are on or measured by net income or receipts may be included in the pass-through entity’s effective tax rate for a particular jurisdiction. A pass-through entity’s aggregate effective tax rate cannot include taxes imposed against the entity’s shareholders, partners, members, or beneficiaries. If a pass-through entity elects to file a composite return in a jurisdiction on behalf of some or all of its shareholders, partners, members, or beneficiaries, the tax rate applicable to that composite return cannot be included in the entity’s effective tax rate for that jurisdiction.

Tax 3.01(4)(e)3.c. c. The tax rate of any jurisdiction where the taxpayer files with the related entity or the related entity files with another entity a combined or consolidated report or return if the report or return results in eliminating the tax effects of transactions, directly or indirectly, between either the taxpayer and the related entity or between the related entity and another entity.

Tax 3.01(4)(e)4. 4. ‘Items includible in aggregate effective tax rate.’ The following are included in the computation of the aggregate effective tax rate:

Tax 3.01(4)(e)4.a. a. Withholding taxes, such as the one imposed by s. 71.775, Stats., paid on income distributable to owners or beneficiaries of the pass-through entity, may be considered entity-level taxes if the state, U.S. possession, or foreign country imposes the withholding as a tax on the income of the pass-through entity.

Tax 3.01(4)(e)4.b. b. The Wisconsin economic development surcharge, which is imposed on tax-option (S) corporations pursuant to s. 77.93 (1), Stats.

Tax 3.01(4)(e)5. 5. ‘Dividends paid deduction.’ If the related entity is not taxed on some or all of its income in a state, U.S. possession, or foreign country because the entity is eligible for a dividends paid deduction under the laws of that jurisdiction, the amount of income considered to be included in its tax base in that jurisdiction is the amount of income after applying the dividends paid deduction. If the dividends paid deduction is less than 100 percent of the related entity’s total income, a pro rata share of its income from the transaction is deemed to be excluded from its tax base in that jurisdiction.

Tax 3.01(4)(e)6. 6. ‘Related entity has loss or credit carryforwards.’ For purposes of applying the test under par. (e), the related entity’s aggregate effective tax rate is computed without regard to loss carryforwards or credit carryforwards. If the related entity has no tax liability in a particular state, U.S. possession, or foreign country because of its loss or credit carryforwards, the related entity’s effective tax rate in that jurisdiction still remains that jurisdiction’s maximum statutory tax rate multiplied by the related entity’s apportionment percentage in that jurisdiction.

Tax 3.01 Note Example: Taxpayer A makes a $500,000 interest payment to Corporation C, a related corporation. Corporation C has no other income and is engaged in business only in State X. Corporation C has a $1,000,000 loss carryforward in State X and uses this carryforward to offset the $500,000 related entity interest income from Taxpayer A. Therefore, Corporation C owes no tax to State X. State X has a maximum corporation income tax rate of 6.2%. Corporation C’s aggregate effective tax rate would be 6.2%.

Tax 3.01(5) (5) Disallowed related entity expenses.

Tax 3.01(5)(a) (a) General. A related entity may subtract income that corresponds to related entity expenses if such expenses are disallowed to the taxpayer.

Tax 3.01(5)(b) (b) Subtraction for disallowed expenses. Except as provided in par. (f), if a taxpayer cannot deduct a related entity expense it paid, accrued, or incurred to a related entity because the expense did not meet one of the tests under sub. (4), the related entity may subtract the income that corresponds to the expense that was disallowed to the taxpayer.

Tax 3.01(5)(c) (c) Form required to substantiate income exclusion. Unless otherwise provided by the department, both the taxpayer and the related entity shall complete the form prescribed by the department to substantiate the income exclusion. The related entity shall file the completed form prescribed by the department with its Wisconsin income or franchise tax return on which it is claiming the subtraction from income. If the related entity is not doing business in Wisconsin, neither the taxpayer nor the related entity has to complete the form prescribed by the department to substantiate the income exclusion.

Tax 3.01(5)(d) (d) Expense below disclosure threshold. Except as provided in par. (e), the subtraction from income provided in this subsection may apply even if the disallowed related entity expense was below the threshold of $100,000 under sub. (7) (b) 3.

Tax 3.01(5)(e) (e) Related entity income exclusion limitation. A taxpayer may not use the form prescribed by the department to disallow related entity expenses to claim a related entity expense if all of the following conditions apply:

Tax 3.01(5)(e)1. 1. The primary motivation for the transaction was one or more business purposes other than the avoidance or reduction of state income or franchise taxes.

Tax 3.01(5)(e)2. 2. The transaction changed the economic position of the taxpayer in a meaningful way apart from tax effects.

Tax 3.01(5)(e)3. 3. The expenses were paid, accrued, or incurred using terms that reflect an arm’s length relationship.

Tax 3.01(5)(f) (f) Evasion of taxes and distortion of income. A taxpayer meeting the criteria to deduct related entity expenses under s. 71.80 (23), Stats., but fails, whether intentionally or not, to disclose such related entity expenses as prescribed, the department at its discretion may disallow the corresponding income exclusion to the related entity and allow the expense to the taxpayer.

Tax 3.01 Note Example: Taxpayer A and Taxpayer B are related entities. A’s net income for the year is $50,000 and B’s net income is $750,000. A incurred $100,000 in interest expenses to B. Realizing there is a benefit to not disclosing the related entity expenses, A reports $150,000 in net income, and B reports $650,000 in net income. The department may disallow the interest income exclusion to B and allow the interest expense to A. As a result, A must report $50,000 of net income and B must report $750,000 of net income.

Tax 3.01(6) (6) Miscellaneous rules.

Tax 3.01(6)(a) (a) Combined groups.

Tax 3.01(6)(a)1. 1. As provided in s. Tax 2.61 (6) (a) 6., for related entity expenses paid, accrued, or incurred between combined group members, including pass-through entities owned by those members to the extent of their distributive shares of income, the addition modifications for related entity expenses under ss. 71.26 (2) (a) 7. and 71.45 (2) (a) 16., Stats., are not required to the extent the recipient of the income includes the income in the combined unitary income. The provisions under s. Tax 2.61 (6) (a) 6. only apply to corporations that are combined group members at the time of the transactions resulting in related entity expenses.

Tax 3.01(6)(a)2. 2. The addition modifications for addbacks are required in cases where related entity expenses are included in combined unitary income but the corresponding income is or was not included in the combined unitary income. To illustrate, without limiting the application of this subdivision in any way, a related entity expense paid, accrued, or incurred to a related entity that is not a combined group member is subject to the addback provisions. Likewise, a related entity expense paid, accrued, or incurred to a combined group member that excluded the corresponding income from the combined unitary income is subject to the addback provisions.

Tax 3.01(6)(b) (b) Pass-through entities. Shareholders of a tax-option (S) corporation, members of a limited liability company treated as a partnership, partners of a general or limited partnership, and beneficiaries of trust and estates need not make an addition modification to their respective incomes in cases where their respective schedules K-1 report the related entity expenses as fully deductible.

Tax 3.01(6)(c) (c) Disregarded entities. Transactions resulting in related entity expenses between an entity that is disregarded for Wisconsin income and franchise tax purposes and its owner need not be reported and disclosed.

Tax 3.01(6)(d) (d) Individual itemized deduction credit. An individual who has paid, accrued, or incurred related entity expenses is not required to disclose such expenses on a form prescribed by the department if the individual reports the expenses as part of the individual’s itemized deduction credit under s. 71.07 (5), Stats. An individual wishing to treat related entity expenses as business expenses shall disclose such expenses on a form prescribed by the department as applicable.

Tax 3.01(6)(e) (e) Taxpayers subject to apportionment. If a taxpayer is subject to apportionment, the taxpayer shall report and disclose the amounts that are required to be added back before apportionment. For purposes of determining the threshold amount of $100,000 under sub. (7) (b) 3., the taxpayer shall use the apportioned amounts. However, the taxpayer shall not multiply by the apportionment percentage those amounts of related entity expenses added back to income that are not attributable to apportionable income. The apportionment percentage shall be recomputed after any addbacks.

Tax 3.01(7) (7) Administration and compliance.