Wisconsin Sales Tax Change Impacts Contractors with Disregarded Entities Part 2

Melissa Lutgen, CPA Tax Senior Manager   email
May 2010

In the April 2010 edition of The Adviser, Part 1 of this article discussed the impact of Wisconsin's new law regarding sales and use tax for single-owner entities. Prior to July 1, 2009, a single-owner entity was disregarded for income tax purposes but was regarded as a separate entity for Wisconsin sales and use tax purposes. A single-owner entity [typically a Limited Liability Company (LLC) or a Qualified Subchapter S Subsidiary (QSub)] could be established to facilitate the purchase of materials used in real property construction for tax-exempt entities to minimize state sales and use tax. Single-owner entities could also be utilized as transportation or leasing companies as a means to save on sales and use tax. After July 1, 2009, however, single-owner entities are now disregarded entities for Wisconsin sales and use tax, eliminating the benefit of establishing single-owner entities as a means of providing sales and use tax savings.

Despite this recent Wisconsin law change, some tax-saving opportunities may still exist, but it may be more difficult to achieve these benefits. A separate taxable entity can still be established and utilized; however, rather than employing a single owner in a parent-subsidiary arrangement, a brother-sister type approach is needed to facilitate the sales and leasing transactions noted above. There are many important factors and issues to evaluate before setting up a separate company aimed at realizing these sales tax benefits. Some of these considerations may include, but are not limited to, the following.

• Legal Structure and Ownership of the Separate Company - Will the new company be organized as a C Corporation, S Corporation or Partnership? Will the ownership mirror that of the contractor, or will there be a different ownership structure? Will both companies be part of a controlled group for federal tax purposes?

• Capitalization - What will be the initial capitalization of the new company? Will only cash be contributed? Or, will other assets also be used? If the contractor's assets are used, how will they be transferred to the new company? Also, if the entity is now a single-owner LLC or QSUB and it is transferred from its parent, how is this transfer structured? A taxable event may be triggered upon the transfer from the contractor.

• Legal Issues - An attorney should be consulted throughout the entire process. Discuss whether it makes sense to form a new company and, if so, what is the best structure for the new company? If the process advances, attorneys will draft articles of incorporation or organization, company by-laws and other necessary legal agreements for the new company. Any contracts for the new company will need to be examined to make sure that the contracts are legally binding and work with the end-customer to secure the sales tax savings.

• Management and Operations - Who will manage and operate the new company? It will need its own board and set of officers. Will a separate financial statement be needed for the new company? If so, will it need to be combined with the related contractor?

• Bonding Company - Will any bonding or surety arrangements need to be revised with the formation of the new company? Will any insurance policies require changes or modifications?

• Personnel and Payroll - Who will be employed by the new company? Will there be separate employees of the new company, or will some work for both companies? Will a "common paymaster" arrangement be employed for overlapped employees for payroll tax purposes? Will retirement and benefit plans be offered to the employees?

• Possible Overlap of Services - There may be an overlap of the services provided by the new company and the contractor. Will these issues be compensated for and reimbursed by each party? To maintain separate company status, the companies will need to operate in such a manner, and perhaps have agreements in place to handle similar situations.

These are just of few of the issues to consider, in addition to other legal, business, accounting and operational issues that will develop and need to be addressed. Careful planning and analysis are necessary before incurring the costs and risks of forming a new company. Please consult your tax adviser and attorney prior to establishing a new company to facilitate purchasing materials, leasing equipment or serving as a transportation company in anticipation of saving state sales and use tax. For more information, please refer to the Wisconsin Department of Revenue Tax Bulletin (No. 166) pages 13-18 published, May 1, 2010.

If you have any questions regarding disregarded entities, please contact Melissa Lutgen.