Wisconsin Requires Nonresident Withholding in Year of Income Despite Prior Year Losses
October 31, 2022
By: Jeff Glickman, SALT Partner
At a glance
- The main takeaway: Several partnerships with indirect interests in Wisconsin real estate were found liable for nonresident withholding taxes, including penalties and interest, for failure to file during an income-producing year, despite excess losses from prior years.
- Assess the impact: Nonresident pass-through withholding can be a compliance nightmare, which is why it’s crucial for multi-tier pass-through entity structures to understand what each entity is and is not doing from a tax filing perspective.
- Take the next step: Aprio’s State and Local Tax (SALT) team can navigate your business through the requirements of a nonresident pass-through withholding to ensure you avoid unexpected tax liabilities and penalties.
Schedule a free consultation today to learn more!
The full story:
When conducting due diligence on a target, the second most common issue that we address for non-compliance exposure (after sales tax) is nonresident pass-through withholding tax. States generally require pass-through entities to pay withholding tax on income allocated and/or distributed to a nonresident owner. However, as with all multistate issues, each state has its own compliance requirements and procedures. A recent Wisconsin Tax Appeals Commission (TAC) decision addresses nonresident withholding filing obligations in an income year that was preceded by several years of losses.
Take a closer look at the case
In that case, there were several partnerships (taxpayers) that each had nonresident owners. The taxpayers owned an interest in a partnership, Watermark Wisconsin Investors LP (Watermark). Watermark invested in another partnership, Watermark Montclair Wisconsin Hotels LLC (Montclair). Montclair owned real estate located in Wisconsin.
For tax years 2006 through 2012, the Montclair and Watermark pass-through to the taxpayers was about $2.5 million in tax losses. In 2013, the taxpayers were allocated income of about $1.5 million. For each of those years, Watermark filed a Wisconsin partnership tax return on Form 3 and reported the taxpayer’s share of income/loss on Wisconsin Form 3K-1. However, Watermark did not file a pass-through withholding tax return, Form PW-1, for any of those years.
The taxpayers did not file any Wisconsin partnership tax returns for years 2006 through 2012 (the years of loss). During an audit of the taxpayers, the auditor requested that the taxpayers file Wisconsin partnership returns, which they did. However, they did not file any pass-through withholding tax returns, and the state issued assessments for tax, interest, penalties and late filing fees totaling about $350,000 in the aggregate.
The ruling explained
Under Wisconsin law, “a pass-through entity that has Wisconsin income for the taxable year that is allocable to a nonresident . . . shall pay a withholding tax.” However, withholding is not required when the owner’s “share of income from the pass-through entity that is attributable to this state is less than $1,000.”
The taxpayer’s argued that they were not required to file pass-through withholding tax returns because the prior year losses offset the 2013 income to effectively make Wisconsin income equal to zero for 2013. However, the TAC explained that the taxpayer’s argument looks at what Wisconsin “taxable income” would be, and the withholding statutes refer to “income” and not “taxable income.” Therefore, the taxpayers were required to file Wisconsin pass-through withholding tax returns and the assessments were upheld.
There are two interesting points to note from this decision:
- First, the TAC points out that the failure of Watermark (the lower-tier partnership) to file the required pass-through withholding tax returns for 2013 did not relieve the taxpayers from their obligations to do so. Therefore, it is especially important in a multi-tier pass-through entity structure to understand what each entity is and is not doing from a tax filing perspective.
- Second, due to the failure to file the required pass-through withholding tax returns, the TAC would not address any questions related to how the taxpayers may have been able to account for the prior year losses, including whether those losses could have offset the 2013 income to reduce or eliminate any potential withholding tax liability. Thus, by not filing, the tax assessments (including penalties and interest) are based solely on the 2013 income, compounding the exposure.
The bottom line
Nonresident pass-through withholding, particularly for multistate partnerships with owners that reside in different states, can be a compliance nightmare. However, failure to comply with these withholding obligations can give rise to exposure that may succeed to a purchaser of the business, even in an asset deal.
Aprio’s SALT team has the experience to help your business address these requirements in order to avoid unexpected tax liabilities, penalties and having this issue arise in due diligence. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the October 2022 SALT newsletter.
 RADS Partnership et. al., v. Wisconsin Dep’t of Rev., Docket Nos. 19-W-281, 19-W-282, 19-W-283, and 19-W-284, Wisconsin Tax Appeals Commission, July 25, 2022.
 Wis. Stat. § 71.775(2)(a).
 Wis. Stat. § 71.775(3)(a)(2.
Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.
About the Author
Jeff Glickman is the partner-in-charge of Aprio, LLP’s State and Local Tax (SALT) practice. He has over 18 years of SALT consulting experience, advising domestic and international companies in all industries on minimizing their multistate liabilities and risks. He puts cash back into his clients’ businesses by identifying their eligibility for and assisting them in claiming various tax credits, including jobs/investment, retraining, and film/entertainment tax credits. Jeff also maintains a multistate administrative tax dispute and negotiations practice, including obtaining private letter rulings, preparing and negotiating voluntary disclosure agreements, pursuing refund claims, and assisting clients during audits.