Wisconsin Court Overturns Software Tax, But Budget Impact Still Unclear

CHICAGO - Wisconsin finance officials will spend the next several months "assessing" the full impact - projected to be $277 million - of a state Supreme Court decision last week overturning the sales tax on customized computer software, but no budget action is expected until after November when new revenue estimates are due.

The state's high court Friday in a divided ruling affirmed the Tax Appeals Commission's decision that Wisconsin had improperly levied a 5% sales tax on customized computer software purchased by Menasha Corp., which then modified the software. The company first challenged the tax in 1998. The commission's decision was later overturned by a Dane County Circuit Court judge, although the appellate court then reversed the circuit court's action.

The packaging company had argued that modified software should not be subject to the sales tax. The state had argued that the software was pre-written and therefore should be subject to the tax as tangible property.

The Supreme Court affirmed the appellate court's ruling, finding that the Tax Appeals Commission reasonably concluded that the software should be exempt from the tax. The commission is "the final authority for hearing and determination of all questions of law and fact" tax issues, the majority opinion read.

The high court's decision eliminates a revenue stream that had generated about $28 million annually of the roughly $4 billion generated by the 5% sales tax. It also could result in refunds owed to other companies totaling about $277 million, according to the state's Legislative Fiscal Bureau. Companies seeking refunds have about six months to seek reimbursement from the state.

The already cash-strapped state can absorb the $28 million loss, but the one-time refund poses a more significant challenge, officials said. The government has a slight cushion to address the shortfall as officials currently anticipate a roughly $106 million ending balance when they close the books on the fiscal biennium June 30, according to budget director David Schmiedicke.

The fiscal bureau, however, will release an annual update on revenue projections Nov. 20 providing a clearer assessment of the state's finances for the remainder of the biennium and projections going into the next. It is then that Gov. Jim Doyle's administration will decide how to address the potential shortfall, Schmiedicke said.

"Between now and then, the Department of Revenue will be assessing the full impact," he said. "By November, we also will be putting the next budget together," leaving room to soften the impact on the current spending plan. "It is another challenge, but we have challenges in every budget."

The court's ruling comes as Wisconsin is battling with one of its tribes over a $92 million payment owed during the current fiscal year under the state's compact with tribes that operate casinos. A federal court last week sent the dispute between Wisconsin and the Ho-Chunk Nation to arbitration.

The Legislature this spring passed a so-called budget repair bill to eliminate a $527 million deficit in the current two-year $57 billion budget. After some alterations made by Doyle using his veto pen, the budget relied on $270 million in cuts, $57 million from the state's reserve, $150 million in upfront savings from a tobacco bond restructuring, and other measures such as closing corporate tax loopholes.

General fund tax revenues are projected to grow by 3.1% in the current fiscal year, with personal income tax collections growing by 4.6% and sales taxes by 2%. About $65 million of the estimated $106 million ending balance was to go into a now-depleted budget reserve.

The state faces a $1.7 billion structural imbalance as a new budget is crafted for the next fiscal biennium. Recent rating agency reports noted as a weakness Wisconsin's narrow fiscal position. The state's current GO ratings are AA-minus by Fitch Ratings and Standard & Poor's and Aa3 with a negative outlook by Moody's Investors Service.

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