On December 1, 2007, while Michigan taxpayers were analyzing the impact of the new Michigan Business Tax and the Sales Tax on Services, the legislature changed the Michigan Business Tax and repealed the Sales Tax on Services. This alert will attempt to briefly summarize the current business tax situation in Michigan and provide suggestions on matters that may require immediate attention.
Sales Tax on Services
The Sales Tax on Services was in effect for one day. Anyone that collected any tax has the option of returning it to the customer or paying it to the State of Michigan by January 20, 2008. Penalties of up to 25% of the tax can be levied on those who retain collected Sales Tax on Services. Anyone that failed to collect the tax will receive amnesty.
Michigan Business Tax
The Michigan Business Tax (“MBT”), effective January 1, 2008, replaces the much maligned Single Business Tax. It has two components: The Business Income Tax will tax unitized and adjusted business income allocated to Michigan at 4.95%. In addition, the Modified Gross Receipts Tax will tax unitized and modified Gross Receipts allocated to Michigan at 0.8%. Small businesses may pay one alternate tax of 1.8% on Gross Receipts allocated to Michigan.
To replace the revenue lost by the repeal of the Sales Tax on Services, a MBT surcharge of 21.99% will be assessed on most taxpayers subject to the MBT. This increases the effective rates as follows:
Business Income Tax: from 4.95% to 6.038%
Modified Gross Receipts Tax: from 0.8% to 0.976%
Alternate Small Business Tax: from 1.8% to 2.196%
- “Adjusted business income” is that amount that would approximate federal taxable income from an MBT taxpayer irrespective of whether it is a pass-through entity such as an S corporation, limited liability company, or partnership, trust or estate. However, self-employment income of owners may be deducted except to the extent attributed to return of capital.
- “Modified Gross Receipts” is gross receipts from a business subject to the tax less purchases of inventory, capital equipment subject to depreciation or amortization and supplies. Also excluded are certain payments received as an agent for others.
- A small business eligible for the alternative rate of 1.8% (or 2.196% after surcharge) on gross receipts is a business with less than $18 million (phasing out to $20 million) in gross receipts, no officer receiving more than $160,000 (phasing out to $180,000) per annum compensation and business income of less than $1.3 million.
Who Is Subject to the MBT?
All trade or businesses deemed operating in Michigan and selling or renting real estate or personal property, or rendering services, or a combination of thereof, for gain is subject to the MBT. This would include individuals (except as an employee or director), limited liability companies, S corporations, trusts and estates.
A significant “clarification” was included in the December 1, 2007 amendments to the tax act. Without this “clarification”, it was feared that many taxpayers would flee the State of Michigan for more accommodating jurisdictions. The “clarification” was that the MBT would not apply to investment transactions or sale of assets that had been put to a personal use, such as the sale of your home or car. Investment transactions include gain on sales of investments, interest and dividends. This exclusion would apply only to: (a) individuals; (b) estates; (c) partnership organized exclusively for estate and gift planning purposes; and (d) trusts organized exclusively for estate and gift planning purposes. This exclusion does not apply to investment income from trusts or partnerships not created exclusively for estate and gift tax planning. The exemption does not apply to the sale or rental of property, if the sale or rental of the property is an integral part of taxpayer’s regular trade or business. If interest, dividends and gains are related to such regular trade or business, they are included as business income. Income from the sale of a business is also business income.
The tax is levied on all entities that provide goods or services in Michigan that are not exempt from federal tax. Financial institutions and insurance companies which have their own version of the MBT. If a unitary business group has Gross Receipts apportioned to Michigan that do not exceed $350,000, no tax is due. At $350,000 in apportioned Gross Receipts, an MBT return is not required. An MBT return is required if Gross Receipts are greater than $350,000 whether a tax is due or not. The tax is reduced proportionately when Gross Receipts are from $350,000 to $700,000, with the reduction eliminated at $700,000.
The MBT is designed to treat all related businesses in the United States as one taxpayer. This is the Unitary Business Concept. Related businesses are those businesses which meet two tests: 1) the ownership test where one person owns directly or indirectly more than 50% of each business; and 2) either value flows from one to the other or they are somehow integrated and interdependent. Income and Gross Receipts within each business and group are allocated to Michigan based on a single apportionment factor – sales with a destination or services rendered in Michigan. Sales with a destination outside the State of Michigan may be excluded from being deemed Michigan sales only if the sales are subject to tax in the other jurisdiction. Other apportionment methods may be used only with the approval of the Michigan Department of Treasury.
Michigan has enacted as broad a standard as possible to bring business outside of Michigan within the grasp of the MBT. Sales of over $350,000 a year from outstate with a Michigan destination are enough to subject the sender to the MBT. More than one day presence in Michigan of a sales person could impose the tax on the company represented.
A myriad of credits are available to reduce the MBT. The credits available for the superseded Michigan Single Business Tax remain available for the MBT. The principal new credits are as follows:
- 0.296% of compensation paid in Michigan reduced from 0.37% in the original Act for 2008; (limited to 50% of the MBT);
- 2.32% of the cost of tangible assets, including fabrication and installation of depreciable assets, placed in Michigan, reduced from 2.9% for 2008;
- 1.52% of research and development expenses in Michigan reduced from 1.9% for 2008.
These three credits cannot reduce the MBT by more than 65%:
- 35% of personal property taxes levied after December 31, 2007 on most personal property. This credit is not available unless a timely filed personal property tax return is filed. A personal property tax return must be filed on or before February 20, 2008 and each following year to be eligible for the credit.
Direct Personal Property Tax Reduction
Part of Michigan’s tax restructuring was a direct reduction in personal property taxes paid on commercial and industrial property. The reduction was 24 mils for personal property classified as industrial and 12 mils for commercial personal property. This approximates a reduction of 65% for industrial personal property and 23% for commercial personal property.
The MBT is due in quarterly installments. For a calendar year taxpayer, installments are due April 15, July 15, October 15 and January 15. Each installment should equal 25% of at least 85% of the MBT liability for the year. An installment is due April 15, 2008 and penalties are provided for failure to comply. Reliance on the previous Michigan Single Business Tax will not be sufficient to avoid imposition of penalties for failure to comply.
What Should We Be Doing Now?
- The State has as broad a standard for subjecting business to the MBT as it could legally enact. Some tax professionals feel it has gone beyond federally imposed limits. In addition the Unitary Business Concept will group together a number of business entities that would otherwise be exempt because of size and make them taxable. A review should be performed to see if the tax would be applicable under these new rules.
- An installment is due April 15, 2008 for all calendar year taxpayers. A good faith estimate of the tax should be performed. Penalties will be imposed for failure to comply.
- The exemption for investment income for trusts and partnerships (including limited liability companies) applies only if the trust or partnership was created exclusively for gift and tax planning. Perhaps a reshuffling of the activities of trusts or partnerships should be considered to clarify that the purpose was exclusively for estate and gift planning.
- Personal property tax returns required by local assessors should be given heightened attention. Initially, they should be filed by February 20, 2008 to get the MBT credit. Further, the classification of the personal property becomes very important because of the increased reduction in millage afforded industrial property as compared to commercial.
- A reevaluation of the split between dividends and compensation for S corporation shareholders should be made in light of the Business Income Tax component of the MBT.
This information is not intended to give a full explanation of the provisions of the Michigan Business Tax nor is it sufficient to ascertain the potential MBT liability of any single taxpayer. The exceptions and qualifications for each provision of the MBT are extensive and require review of a taxpayer’s individual operations before any tax calculation can be relied upon.
The State of Michigan has established a website which conveys detailed information and includes a tax estimator. We at Berry Moorman are always ready to assist any of you. Please visit our Tax Practice page for more information.