The Michigan Business Tax: New Developments

Editor: Frank J. O’Connell Jr., CPA, Esq.

Since being enacted in July 2007, the Michigan Business Tax (MBT) has undergone constant legislative changes and administrative clarifications in the form of revenue administrative bulletins (RABs) and frequently asked questions (FAQs) issued by the Michigan Department of Treasury (see Treasury’s website at www.michigan.gov/taxes under the Michigan Business Tax section for the latest RABs and FAQs). Following are summaries and excerpts from some of the more significant changes (for more details of the MBT as it was originally enacted, see Wright, “The Michigan Business Tax: Overview and Issues to Consider,” 38 The Tax Adviser 750 (December 2007)). These changes include nexus defined for MBT purposes, unitary taxation under the MBT, small business provisions, the MBT surcharge, and an MBT credits update.

Note: Numerous additional changes are being proposed to the MBT as this item goes to press. A significant change that could affect many businesses is a proposal to modify the definition of gross receipts, which would permit a deduction from the modified gross receipts tax base for, among other things, bad debts and taxes collected on behalf of the state (see proposed S.B. 1038).

Nexus Defined for MBT Purposes

In its RAB 2007-6, issued on December 28, 2007, the department complied with its statutory mandate under Mich. Comp. Laws §§208.1200(1) and (2) to define “actively solicits” for nexus standard purposes. A business taxpayer will have nexus under the MBT

[i]f the taxpayer has a physical presence in this state for a period of more than 1 day during the tax year or if the taxpayer actively solicits sales in this state and has gross receipts of $350,000.00 or more sourced to this state.

In the RAB the department defines “actively solicits” to mean

purposeful solicitation of persons within this state. Solicitation means: (1) speech or conduct that explicitly or implicitly invites an order; and (2) activities that neither explicitly nor implicitly invite an order, but are entirely ancillary to requests for an order.

In the RAB the department further explains that

solicitation is purposeful when it is directed at or intended to reach persons within Michigan or the Michigan market. Active solicitation includes, but is not limited to, solicitation through: (1) the use of mail, telephone, and e-mail; (2) advertising, including print, radio, internet, television, and other media; and (3) maintenance of an internet site over or through which sales transactions occur with persons within Michigan. Examples of active solicitation provided by the department include sending mail order catalogs; sending credit applications; maintaining an internet site offering online shopping, services, or subscriptions; and soliciting through media advertising, including internet advertisements.

Probably the most controversial position taken by the department relates to its attempt to subject internet retailers to the modified gross receipts portion of the MBT. For this portion of the MBT the department claims that no physical presence in Michigan is required and that, as explained in Example 1 from their RAB, merely having $350,000 in Michigan gross receipts and having a website whereby Michigan residents can place orders is sufficient to create nexus for MBT purposes.

A retailer located outside Michigan maintains an internet site over and through which customers may browse products and place orders. The internet site is generally available to all persons throughout the country. Through maintenance of the interactive site, the retailer intends to reach all persons and markets, including persons within Michigan and the Michigan market. The retailer is actively soliciting sales in Michigan.

Another controversial position that the department has now taken in a new draft RAB on nexus is how physical presence in Michigan for a period of more than one day during the tax year will be applied. For nexus to exist, there should be a connection between the taxpayer’s in-state activities and the taxpayer’s attempt to establish or maintain a market in Michigan. This nuance was recognized in RAB 1998-1, which provided departmental guidance on the SBT nexus standard, whereby certain activities could be carried on in Michigan without those activities alone creating nexus. They included such things as meeting with in-state suppliers of goods or services; in-state meeting with government representatives in their official capacity; attending occasional meetings (e.g., board meetings, retreats, seminars and conferences sponsored by others, etc.); holding recruiting or hiring events; renting to or from an in-state entity customer list; and/or attending and/or participating at a trade show at which no orders for goods are taken and no sales are made.

As there is no statutory exemption for these activities, even though they are not taking place in Michigan to establish or maintain a Michigan market, the department has now taken a hard line in its new draft RAB on nexus by saying that more than one day of any of these activities, alone or in combination, will create nexus. Now that the department has taken this position, many out-of-state businesses may think twice about using Michigan suppliers, holding meetings or attending conventions in Michigan, or recruiting Michigan citizens for jobs in other states.

Finally, the department’s MBT nexus RAB states that “active solicitation, coupled with $350,000 in Michigan gross receipts, constitutes nexus under the MBT and satisfies the Due Process and Commerce Clauses of the U.S. Constitution.”

While the department is entitled to its opinion as to the constitutionality of these nexus standards, it will be left to the courts to decide whether or not some of these extremely aggressive nexus standards do in fact satisfy both the due process and commerce clauses of the U.S. Constitution.

Unitary Taxation Under the MBT

The Michigan Department of Treasury’s FAQ U33 “What Is a Unitary Business Group?” provides an explanation of the department’s most recent interpretation of the control and relationship tests that must both be met to be considered a unitary business for MBT purposes. For unitary tax purposes the nexus standard is the same as for separate entities. However, because Michigan treats a unitary group as a single taxpayer, thereby ignoring each individual member’s separate legal existence, if one member of the unitary group has nexus in Michigan, all members of the unitary group are considered to have nexus in Michigan (the Finnigan standard; see Appeal of Finnigan Corp., 88-SBE-022, on reh’g (SBE 1/24/90)) and the group is required to file a combined return under Mich. Comp. Laws §208.1511. Further, for purposes of the $350,000 in Michigan gross receipts portion of the active solicitation nexus test, the gross receipts of all members of the group are aggregated. So, for example, if each of the four members of a unitary group has $100,000 in Michigan gross receipts, then the group’s $400,000 in Michigan gross receipts would exceed the $350,000 threshold and the group would have nexus in Michigan and would have to file an MBT return.

According to various department FAQs, the designated member of a unitary business group must register with the department for the MBT. “Designated member” means a member of a unitary business group that has nexus with Michigan under Mich. Comp. Laws §208.1200 and that will file the combined return required under Mich. Comp. Laws §208.1511 for the unitary business group. Only the designated member must register, and the MBT return will be filed under its FEIN. If the member that owns or controls the other members of the unitary business group has nexus with Michigan, then that controlling member must be the designated member. Otherwise, the designated member can be any member of the unitary business group with nexus. The unitary group must use the tax year of the designated member, so, for any entities that have a different tax year, the combined return of the unitary business group must include each tax year of each member whose tax year ends with or within the tax year of the designated member.

Small Business Provisions

The MBT has a credit similar to the small business credit that was available under the single business tax (SBT), but the language was expanded to include members of limited liability companies (Mich. Comp. Laws §208.1417). The credit is also being referred to as an alternative calculation for small businesses. The alternative calculation is adjusted business income multiplied by a reduced tax rate of 1.8% (Mich. Comp. Laws §208.1417(4)).

To be eligible for the reduced tax rate, taxpayers will need to meet the following qualifications: (1) business income minus loss adjustment may not exceed $1.3 million (Mich. Comp. Laws §208.1417(1)); and (2) gross receipts may not exceed $20 million (Mich. Comp. Laws §208.1417(1)) with a phaseout of credit between $19 million and $20 million (Mich. Comp. Laws §208.1417(5)). For individuals, partnerships, limited liability companies (LLCs), or S corporations, the distributive share of an individual, one partner, one member of the LLC, or any one shareholder of the S corporation may not exceed $180,000 of the adjusted business income minus the loss adjustment of the individual, the partnership, the LLC, or the S corporation (Mich. Comp. Laws §208.1417(1)(a)).

For C corporations (Mich. Comp. Laws §208.1417(1)(b)), compensation and directors’ fees of a shareholder or officer may not exceed $180,000, and the sum of the following amounts may not exceed $180,000: compensation and directors’ fees of a shareholder and the product of the percentage of outstanding ownership or of outstanding stock by that shareholder multiplied by the difference between the sum of business income and, to the extent deducted in determining federal taxable income, a carryback or carryover of a net operating loss of capital loss, minus the loss adjustment (add back percentage of net operating loss).

The alternative calculation is applied as if it were a credit. The credit is subject to a phaseout percentage based on the distributive share and/or compensation between $160,000 and $180,000 (Mich. Comp. Laws §208.1417(1)(c)). 

Adjusted business income is defined as federal taxable income derived from business activity, plus compensation and directors’ fees of active shareholders and/or of officers of a corporation; carryback or carryover of a net operating loss (to the extent deducted in determining federal taxable income); and capital loss (to the extent deducted in determining federal taxable income) (Mich. Comp. Laws §208.1417(9)(b)).

The business income limitation will be adjusted annually utilizing the Detroit consumer price index (Mich. Comp. Laws §208.1417(1)). The qualification amounts have been greatly increased over the prior amounts under the SBT, providing additional planning opportunities and increasing the number of taxpayers who may qualify.

MBT Surcharge

Michigan previously passed legislation imposing a use tax on a number of services with an effective date of December 1, 2007. This legislation met with opposition, and the legislature was urged to find an alternative method of meeting deficiencies in the state budget. Public Act (PA) 145, effective December 1, 2007, repealed the services tax and instituted an MBT surcharge to replace the revenue loss from the repealed service tax. The annual surcharge is calculated after allocation and apportionment but before calculation of any credits that are available to the taxpayer. In general, taxpayers doing business in Michigan will have a surcharge of 21.99% imposed on their tax liability before credits. The surcharge is capped at $6 million per taxpayer (Mich. Comp. Laws §208.1281).

Financial institutions are also subject to a 27.7% surcharge for tax years ending during 2008 and a 23.4% surcharge for tax years ending after December 31, 2008, with no cap (Mich. Comp. Laws §208.1281(1)(b)). The surcharge does not apply to financial institutions authorized to execute only trust powers. Insurance companies are also excluded from the surcharge (Mich. Comp. Laws §208.1281(4)).

The surcharge is scheduled to expire on January 1, 2017, if the Michigan personal income growth exceeds zero percent in any one of the three calendar years immediately preceding the 2017 calendar year. “Michigan personal income” means personal income for the state, as defined by the Bureau of Economic Analysis of the U.S. Department of Commerce or its successor (Mich. Comp. Laws §208.1281(2)).

MBT Credits

Although the primary purpose of PA 145 was to institute a surcharge to replace the revenue from the repealed service tax, PA 145 also made a number of additional changes to the MBT. Some of those changes include changes to the compensation credit, the investment tax credit, and the research and development credit. PA 145 also adopted several new MBT credits. The following is a list of some of the changes adopted when the use tax on services was repealed.

Compensation credits: The compensation credit is allowed for compensation paid to employees in Michigan. The credit was reduced to .296% for the 2008 tax year from the originally enacted rate of .37%. For the 2009 tax year and thereafter, the rate returns to .37% (Mich. Comp. Laws §208.1403(2)). The compensation credit generally includes payment to employees in Michigan for all wages, salaries, fees, bonuses, commissions, and other payments made in the tax year on behalf of or for the benefit of employees, officers, or directors of the taxpayers, and any earnings that are net earnings from self-employment as defined under Sec. 1402. Other payments made on behalf of or for the benefit of employees may include 401(k) matches, pretax benefit payments, pensions, and any items included on Form W-2 that are specifically exempted or excepted from federal income tax withholding.

The department indicated in MBT FAQ C28 that

compensation is “in this state” if (a) the individual’s service is performed entirely within Michigan, or (b) the individual’s service is performed both within Michigan and outside Michigan, but the service performed outside Michigan is incidental to the individual’s service within Michigan.

This answer implies that taxpayers with employees who perform their services in several states will need to document the services that are being performed in each state in order to substantiate the compensation credit claimed.

Investment credits: The investment credit is allowed for the cost of new capital assets located in Michigan less any recapture. The credit was reduced to 2.32% for the 2008 tax year from the originally enacted rate of 2.9%. For the 2009 tax year and thereafter, the rate returns to 2.9% (Mich. Comp. Laws §208.1403(3)).

Credit limitations: For the 2008 tax year, the combined compensation credit and the investment tax credit may not exceed 50% of a taxpayer’s MBT liability before the surcharge. For the 2009 tax year and thereafter, these combined credits cannot exceed 52% of a taxpayer’s MBT liability before the surcharge. As originally enacted, the combined total of these two credits could not exceed 65% of the taxpayer’s MBT liability (Mich. Comp. Laws §208.1403(1)).

Research and development (R&D) credit: The R&D credit is allowed for research and development expenses incurred in Michigan during the tax year. The credit was reduced to 1.52% for the 2008 tax year from the originally enacted rate of 1.9%. For the 2009 tax year and thereafter, the rate returns to 1.9% (Mich. Comp. Laws §208.1405).

Credit limitations: The R&D credit, combined with the compensation and investment credits, is limited to 65% of the MBT liability before the surcharge is applied (Mich. Comp. Laws §208.1405). The originally enacted percentage was 75%.

Refundable personal property tax credit: PA 145 added taxes levied on certain public utilities to the definition of property eligible for the refundable personal property tax credit. A 35% credit is allowed for payments made for Michigan industrial personal property taxes. A 23% credit is allowed for payments made for Michigan personal property taxes paid by a telephone company in 2008, and a 13.5% credit is allowed for payments made for Michigan personal property taxes paid by a telephone company in subsequent years. A 10% credit is allowed for payments made for Michigan personal property taxes paid on natural gas pipelines.

Taxpayers must file the Michigan personal property tax statements by the due date of February 20 of each year to be eligible to receive the credit, and the payment must have been made for taxes assessed after December 31, 2007. The only way to receive a refund for the industrial personal property tax credit is to file an MBT return. As such, taxpayers who do not meet the MBT filing threshold or otherwise do not have an MBT filing obligation, but have made payments for qualifying Michigan personal property taxes, should consider filing an MBT return in order to claim the refund (Mich. Comp. Laws §208.1413 (et seq.)).

Other credits: There are a plethora of other MBT credits, and the legislature is enacting new ones all the time. For a listing of the credits, see the Michigan Department of Treasury website and Mich. Comp. Laws §§1409–1453.

Terminated SBT credits: SBT credits that are no longer available under the MBT include the unincorporated business credit, Michigan Economic Development Authority business activity credit, transferred jobs credit, minority venture capital company credit, high-technology activity credit, created jobs credit, donated automobile credit, apprenticeship credit, pharmaceutical research credit, and enterprise zone credit. All these credits may be carried forward to the 2008 and 2009 tax years to the extent that the credit could be used under the SBT. After 2009, unused credit carryforwards are extinguished.

EditorNotes:

Frank J. O’Connell Jr. is a partner in Crowe Chizek in Oak Brook, IL.

Unless otherwise noted, contributors are members of or associated with Crowe Chizek.

For additional information about these items, contact Mr. O’Connell at (630) 574-1619 or foconnell@crowechizek.com.