In 2009, the Wisconsin capital gain exclusion was reduced from 60 percent to 30 percent. This increased the Wisconsin tax on capital gains by 75 percent for most Wisconsin taxpayers (from 2.7 percent to approximately 4.7 percent) and by 100 percent for higher income taxpayers (from 2.7 percent up to approximately 5.4 percent). Therefore, finding an exception to the higher Wisconsin capital gains tax is more valuable now than ever before. In part one of a two part series, we will address capital gains opportunities in Wisconsin for the sale of qualified small business stock and the sale of business and farm assets to related persons. Wisconsin's recently passed 2011 Budget Bill contained various tax changes which included several new provisions in the Wisconsin incentives for capital gains, and these changes will be explored in part two of the series in our next issue of The Adviser.
Qualified Small Business Stock (QSBS). A 100 percent capital gain exclusion for Wisconsin purposes applies for the sale of stock in a qualified small business. A qualified small business is defined as a company that:
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has at least 50 percent of its payroll and property attributed to Wisconsin;
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has no more than 500 employees;
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derives no more than 25 percent of its gross receipts from rents, interest, dividends and sales of intangible investment assets combined;
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has not previously issued stock that is traded on the New York Stock Exchange, the American Stock Exchange or NASDAQ; and
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has not liquidated or reorganized for purposes of qualifying for this exclusion.
In addition, the following requirements must be met in order for the stock to be considered qualified small business stock. The stock:
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must have been acquired on or after January 1, 1986;
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cannot have been acquired by gift or in a stock-for-stock exchange; and
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must have been held for at least five years.
The corporation must certify that it met the above requirements. A copy of the certification must be included with the taxpayer's Wisconsin Individual Income Tax Returns (Form 1) that is filed for the year of the sale.
The Wisconsin QSBS exclusion should not be confused with the federal small business stock exclusion (IRC Section 1202). The federal exclusion is now at 100 percent for stock acquired after September 27, 2010, and before January 1, 2012. The federal small business stock exclusion has different requirements than the Wisconsin QSBS exclusion, so careful planning is needed.
Exclusion for Sales to Family Members. In addition to the QSBS exclusion, Wisconsin law also provides for a 100 percent capital gain exclusion on the transfer of business assets and farming assets between family members. Business assets, for purposes of this exclusion, include shares in a corporation or in a trust. A business asset is defined as an asset used in an activity carried on for a livelihood, or in good faith to make a profit. This determination is based on facts and circumstances of the business. Regularity of activities and the production of income are important elements in this analysis. The business does not actually need to make a profit, but it must exhibit a profit motive. Also, the business must demonstrate an ongoing effort to further the interests of the business.
The following conditions must be met for the exclusion of the capital gain for Wisconsin purposes.
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The farming or business assets must have been held for more than one year.
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The assets must have been sold or otherwise disposed of to persons related (by blood, marriage or adoption) to the seller within the "third degree of kinship" (child, grandchild, great-grandchild, parent, grandparent, great-grandparent, sibling, niece, nephew, aunt or uncle).
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The gain must have been treated as capital gain on the seller's federal income tax return.
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For shares in certain corporations or trusts, the following standards must be met by the corporation or the trust in order for the gain on the disposition of shares in the corporation or trust to qualify for the exclusion:
o it does not have more than two classes of stock;
o it has no more than 15 shareholders or beneficiaries; and
o all of its shareholders or beneficiaries are natural persons or estates.
If the family member who purchased the business assets subsequently sells or otherwise disposes of the assets within two years after the purchase, they will be subject to a penalty. The penalty is the prorated amount of tax that would have been imposed had the original sale been subject to tax.
These exclusions can provide significant Wisconsin tax savings in the right situation. Again, look for the next issue of The Adviser, that will address additional Wisconsin capital gain incentives enacted in the 2011 Budget Bill. For more information, please contact Lynn Keller at lkeller@kolbco.com.