While state taxing agencies generally take the high road, it is important to remember that when they do not, the courts can require them to do so.
In Wisconsin Department of Revenue v. Deere and Company, No. 2020AP726, 2021 Wisc. App. LEXIS 74 (Wis. Ct. App. Feb. 25, 2021), the Wisconsin Court of Appeals held that Deere and Company (“Deere”) was permitted a dividends-received deduction for distributions received from a Luxembourg limited partnership that was treated as a corporation for federal tax purposes. What makes this case particularly significant is that, in doing so, the court ruled that the Department of Revenue (“Department”) was prohibited from arguing otherwise because such an argument was contrary to the Department’s then-existing published guidance.
Facts: Deere and a wholly‑owned single member limited liability company (“Deere LLC”) together owned 100 percent of a limited partnership that was organized under the laws of Luxembourg (“Deere Luxembourg”), but that checked the box to be classified as a corporation. Because Deere LLC was disregarded for federal income taxes, Deere was treated as the sole owner of Deere Luxembourg for tax purposes.
Both Deere and Deere LLC received cash distributions from Deere Luxembourg, which Deere included in its Wisconsin taxable income (including the distributions made to disregarded Deere LLC). Deere then deducted the distributions based on the state’s dividends-received deduction.
The Department disallowed the deduction, asserting that it was only allowed for dividends received from a corporation with respect to its common stock and Deere Luxembourg, as a limited partnership, did not have common stock.
The Appeal: Deere challenged the Department’s disallowance, making two separate arguments. First, Deere argued that the Wisconsin statutes treated Deere Luxembourg as a corporation—since the definition of “corporation” includes an entity that is not organized as a corporation but that is treated as a corporation under the Internal Revenue Code—and therefore the distributions from Deere Luxembourg were dividends from a corporation with respect to its common stock. Second, it argued that the Department could not argue against its published guidance, which provided that a limited liability company that is treated as a corporation under the Internal Revenue Code is treated as a corporation for Wisconsin tax purposes and that an interest in such a limited liability company is treated in the same manner as stock. Wisconsin Dep’t of Revenue, Publication 119: Limited Liability Companies (LLCs) (2019).
While in the earlier administrative appeal, the Tax Appeals Commission agreed with Deere on both arguments, the court did not rule on the first one. Instead, the court looked to a statute that specifically prohibits the Department from taking a position that is contrary to any guidance that it has published, Wisconsin Statute Section 73.16(2)(a), and found that it applied here. That the guidance involved a limited liability company and not a limited partnership was not relevant. Indeed, the court found that the Department’s position against Deere “cannot be reconciled with what the guidance stated about the tax treatment of LLCs that have elected corporate classification.” Wisconsin, 2021 Wisc. App. LEXIS 74 at *14. Consequently, Deere was entitled to the dividends‑received deduction.
This decision is similar to Department of Revenue v. Agilent Technologies, Inc., 441 P.3d 1012 (Colo. 2019), where the Colorado Supreme Court held that the Department of Revenue was bound by its own regulations and, consequently, could not force Agilent to file a combined return with one of its subsidiaries. It is also consistent with the “square corners” doctrine, which the New Jersey courts have applied to preclude the assessment of tax where taxpayers made financial decisions relying on representations by state officials regarding how tax laws will be applied, only to have those officials change position later. E.g., Milligan v. Director, Div. of Taxation, 29 N.J. Tax 381 (N.J. Tax Ct. 2016).
While it is unfortunate that state taxing agencies do not always take the high road, it is good to remember that those transgressions can be successfully challenged in the courts.