The Department of Revenue has prepared a flowchart to help taxpayers and preparers determine if an addition modification or Schedule RT disclosure is required for expenses paid, accrued, or incurred to related entities.
Additionally, the Department has updated its frequently asked questions (FAQs) on these topics:
Three important issues the new guidance addresses are:
When Pass-Through Entities and Their Members Are "Related Entities"
Wisconsin uses the loss disallowance rules provided in section 267 of the Internal Revenue Code (IRC) to determine if a taxpayer is a "related entity." Section 267(b), IRC, lists relationships which are considered to be "related entities" for Wisconsin purposes. Section 267(e)(6) incorporates section 707(b), IRC, relating to partnerships. Under these sections, Wisconsin would determine that:
- A tax-option (S) corporation and its shareholder are "related entities" if the shareholder owns directly or indirectly, more than 50% in value of the S corporation's outstanding stock.
- A partnership and its partner are "related entities" if the partner owns, directly or indirectly, more than 50% of the capital interest or profits interest in the partnership.
How Partnerships and S Corporations Report Addbacks
A partnership or S corporation that has interest or rent expenses paid, accrued, or incurred to a related entity must make a Wisconsin addition modification for those expenses. If the expenses meet the criteria given in Schedule RT, Part II, the partnership or S corporation may make a subtraction modification for the qualifying amount. These modifications must be reported as follows:
- S Corporations: On Schedule 5K (and the respective Schedules 5K-1), report these modifications in two places:
- Column c of lines 1 through 12d, according to the type of pass-through item to which the expense relates (if the entire amount of expense is deductible, the addition and subtraction modifications would cancel out and result in $0 net adjustment), and
- Column d of lines 18a through 18d.
- Partnerships: On Schedule 3K (and the respective Schedules 3K-1), report these modifications in two places:
- Column c of lines 1 through 13d, according to the type of pass-through item to which the expense relates (if the entire amount of expense is deductible, the addition and subtraction modifications would cancel out and result in $0 net adjustment), and
- Column d of lines 21a through 21d.
When to Disclose "Other Related Entity Expenses" on Schedule RT, Line 4c
The "other expenses" that must be disclosed on line 4c of Schedule RT include any expenses paid, accrued, or incurred to a related entity other than those already listed on lines 1 through 4b. In other words, line 4c of Schedule RT is for related entity expenses which are not for interest, rent, royalties, management and service fees, or inventory purchases.
However, line 4c is only required to be completed if the total "other related entity expenses" deducted on the return for the taxable year exceed 10% of the taxpayer's total expenses. In determining whether the expenses exceed 10% of total expenses, "total expenses" include the following:
- Cost of goods sold,
- Any expenses already disclosed on Schedule RT, lines 1 through 4b, and
- Any other expenses that are deducted on the return for the taxable year, whether or not they are paid, accrued, or incurred to related entities.
March 4, 2009