Revenue Administrative Bulletin 2020-26

CORPORATE INCOME TAX SMALL BUSINESS ALTERNATIVE CREDIT

Approved:  December 22, 2020

RAB 2020-26.  This Revenue Administrative Bulletin (RAB) describes the Small Business Alternative Credit (SBAC) and its application under Part 2 of the Michigan Income Tax Act (commonly known as the Corporate Income Tax (CIT)).  In general, the SBAC provides a credit that results in an alternative effective tax rate of 1.8% of adjusted business income (ABI) for qualifying taxpayers.  This RAB will discuss the qualifiers, disqualifiers, and filing requirements for taxpayers claiming the SBAC. 

Introduction:

The intended purpose of the SBAC is to aid small businesses through a credit that results in an effective lower tax rate.  The SBAC is available to any standard taxpayer that meets certain gross receipts and ABI thresholds and is not otherwise disqualified.[1]  The taxpayer’s SBAC is calculated on Form 4893 and carried over to the CIT Annual Return (Form 4891).  Form 4894, CIT Schedule of Shareholders and Officers, must be filed with the return to qualify for the SBAC.  For a unitary business group (UBG) claiming the credit, each member that is a corporation must file a separate Form 4894.  The SBAC will be denied if the required member forms are not included with the return.

Definitions and Key Terms:

Active shareholder means a shareholder who receives at least $10,000.00 in compensation, directors’ fees, or dividends from the business, and who owns at least 5% of the outstanding stock or other ownership interest.[2]

Adjusted Business Income (ABI) means business income as defined in MCL 206.603 with all the following adjustments:

(i) Add compensation and directors’ fees of active shareholders of a corporation.

(ii) Add, to the extent deducted in determining federal taxable income (FTI), a carryback or carryover of a net operating loss.

(iii) Add, to the extent deducted in determining FTI, a carryback or carryover capital loss.

(iv) Add compensation and directors’ fees of officers of a corporation.[3]

Allocated income is a term used in forms, instructions, and this RAB that refers to shareholder compensation plus the shareholder’s share of modified business income less loss adjustment.  A taxpayer is disqualified if a shareholder’s allocated income exceeds $180,000.

Compensation means 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. Compensation includes, but is not limited to, payments that are subject to or specifically exempt or excepted from withholding under Internal Revenue Code (IRC) sections 3401 to 3406. Compensation also includes, on a cash or accrual basis consistent with the taxpayer’s method of accounting for federal income tax purposes, payments to a pension, retirement, or profit sharing plan other than those payments attributable to unfunded accrued actuarial liabilities, and payments for insurance for which employees are the beneficiaries, including payments under health and welfare and noninsured benefit plans and payment of fees for the administration of health and welfare and noninsured benefit plans. Compensation does not include any of the following:

(i) Discounts on the price of the taxpayer’s merchandise or services sold to the taxpayer’s employees, officers, or directors that are not available to other customers.

(ii) Except as otherwise provided in subsection 671(9)(d), payments to an independent contractor.

(iii) Payments to state and federal unemployment compensation funds.

(iv) The employer’s portion of payments under the Federal Insurance Contributions Act, [4] the Railroad Retirement Tax Act,[5] and similar social insurance programs.

(v) Payments, including self-insurance payments, for worker’s compensation insurance or federal employers’ liability act insurance pursuant to 45 USC 51 to 60.[6]

Detroit consumer price index means the most comprehensive index of consumer prices available for the Detroit area from the U.S. Department of Labor, Bureau of Labor Statistics.[7]

This index is used to compute the annual ABI after loss adjustment disqualifier amount.

Loss adjustment means the amount by which ABI was less than zero in any of the 5 tax years immediately preceding the tax year for which eligibility for the credit is being determined. In determining the loss adjustment for a tax year, a corporation is not required to use more of the taxpayer’s total negative ABI than the amount needed to qualify the corporation for the credit. A corporation shall not be considered to have used any portion of the taxpayer’s negative ABI amount unless the portion used is necessary to qualify for the credit. A corporation may not reuse a negative ABI amount used as a loss adjustment in a previous tax year or use a negative ABI amount from a year in which the corporation did not receive the credit.[8]

Modified business income is the sum of business income and, to the extent deducted in determining FTI, a carryback or a carryover of a net operating loss or capital loss.

This amount is used in the calculation of the allocated income disqualifier under subsection 671(2) of the CIT.

Officer means an officer of a corporation including all the following:

(i) The chairperson of the board.

(ii) The president, vice president, secretary, or treasurer of the corporation or board.

(iii) Persons performing similar duties and responsibilities to persons described in (i) and (ii), above, that include, at a minimum, major decision making.[9]

Shareholder means a person who owns outstanding stock in a corporation or is a member of a business entity that files as a corporation for federal income tax purposes. An individual is considered as the owner of the stock, or the equity interest in a business entity that files as a corporation for federal income tax purposes, owned, directly or indirectly, by or for family members as defined by IRC 318(a)(1).[10]

Unitary business group (UBG) means a group of U.S. persons that are corporations, insurance companies, or financial institutions, other than a foreign operating entity, 1 of which owns or controls, directly or indirectly, more than 50% of the ownership interest with voting rights or ownership interests that confer comparable rights to voting rights of the other members, and that has business activities or operations which result in a flow of value between or among members included in the UBG or has business activities or operations that are integrated with, are dependent upon, or contribute to each other. UBG includes an affiliated group that makes the election to be treated, and to file, as a UBG under section 691(2).[11]

Credit Disqualifiers:

Taxpayers are not eligible for the SBAC if gross receipts exceed $20,000,000 or ABI after loss adjustment exceeds $1,300,000.[12] Taxpayers will also be disqualified if any shareholder or officer has compensation and directors’ fees that exceed $180,000 or a shareholder has allocated income after loss adjustment that exceeds $180,000.  A taxpayer that exceeds any of these threshold amounts is disqualified from claiming the credit. 

Gross Receipts and ABI after Loss Adjustment Disqualifiers

Gross receipts are generally the entire amount received from any activity whether in intrastate, interstate, or foreign commerce carried on for direct or indirect gain, benefit, or advantage to the taxpayer or to others with certain statutory limitations.[13]  Taxpayers that have gross receipts that exceed $20,000,000 are disqualified from claiming the credit.

Taxpayers that have ABI after loss adjustment that exceeds $1,300,000, as adjusted, are disqualified from the SBAC. The disqualification amount is adjusted annually for inflation using the Detroit consumer price index and is published in the forms.[14] 

If a taxpayer’s ABI was less than zero in any of the five tax years immediately preceding the tax year that the taxpayer is claiming an SBAC, and the SBAC was claimed in the loss year, the taxpayer may be able to reduce the current year ABI below the indexed ABI disqualifier amount.  Losses available from the five prior years must be used on a first-in, first-out (FIFO) basis until the losses are consumed or extinguished by age.  A taxpayer may not reuse a negative business income (loss) amount that was used as a loss adjustment in a prior year and may only use a loss from a year the taxpayer was able to claim a SBAC.[15]

Example 1. For tax year 2019, the indexed ABI limitation is $1,426,100.  Kamryn and Connor are shareholders and officers in ABC Co.  Kamryn owns 97 percent of the outstanding shares.  Connor owns the remaining 3 percent.  Kamryn received compensation of $150,000 and Connor received compensation of $100,000.  ABC Co. had a capital loss of $750,000.  Federal taxable income after capital loss, but before business loss adjustments, was $427,000.

In 2017, ABC Co. had an adjusted business loss of $800 and received the SBAC.

In 2018, ABC Co. had an adjusted business loss of $250 and received the SBAC.

For 2019 ABC Co. computes its ABI as follows:

Because ABC Co. had business losses in 2017 and 2018, and received the SBAC each year, it may use all $800 of the 2017 loss and $100 of the 2018 loss as its loss adjustment for purposes of satisfying the 2019 ABI limitation of $1,426,100.  The remaining 2018 loss of $150 is available as a loss adjustment in future years.

Compensation and Allocated Income Disqualifiers

A taxpayer will also be disqualified from claiming the credit if (a) the compensation and directors’ fees of a shareholder or officer exceed $180,000 or (b) the compensation and directors’ fees of a shareholder, plus the shareholder’s allocated portion of modified business income less loss adjustment, exceeds $180,000.[16]

Allocated Income

Note that the first test, compensation, (a) above, applies to shareholders and officers.  The second test (referred to as “allocated income” in this RAB and forms and instructions), (b) above, incorporates compensation, modified business income, and a loss adjustment and applies only to shareholders.  The loss adjustment is not available to reduce compensation but is an adjustment to the modified income.  To summarize, “allocated income” and “modified income” are represented as:

Allocated Income = compensation + ((modified business income – loss adjustment) x shareholder %.)

Modified Business Income = business income + net operating and capital loss carryover or carryback deducted in determining FTI.

Example 2. Using the facts from Example 1, Kamryn and Connor are both officers and shareholders of ABC Co.  Neither shareholder/officer has compensation that exceeds $180,000 under the first test.  Under the second test (allocated income) each shareholders’ compensation must be added to their share of the modified business income after loss adjustments.

Because Kamryn’s allocated income exceeds $180,000, ABC Co. is disqualified from claiming the SBAC.

Compensation

Proper calculation of shareholder or officer compensation is necessary for purposes of determining both the compensation and allocated income disqualifiers.  The definition of compensation requires accrual basis taxpayers to adjust accrued wages, salaries, fees, bonuses, and commissions to cash basis when computing compensation.  Other payments such as those made to a pension, retirement, or profit-sharing plan must be accounted for consistent with the taxpayer’s method of accounting for federal income tax purposes.[17]

Example 3. Grant’s employer, a motorcycle manufacturer, uses the accrual method of accounting for federal income tax purposes.  In 2018, Grant had W-2 wages of $48,000.  A year-end bonus of $25,000 and a $15,000 year-end contribution into a profit-sharing plan were accrued on his behalf.  Grant received a $1,500 employee-only discount on a motorcycle he purchased from his employer in 2018.  Grant received the bonus with his first paycheck in 2019.

Assuming none of the W-2 wages require an accrual to cash adjustment, Grant’s 2018 compensations would be:

            Cash wages received                                      $48,000

            Accrued profit sharing                                     $15,000

            2018 Compensation                                        $63,000

The bonus was not paid to Grant until 2019 when it will be recognized in the calculation of compensation.  The profit sharing is recognized as compensation in 2018 consistent with the company’s accrual method of accounting.  The $1,500 employee discount is excluded from compensation by statute.

Compensation paid by a professional employer organization (PEO) to officers of the client and to its employees that are assigned or leased to and perform services for the PEO’s clients is included in the client’s shareholder officer compensation eligibility determinations.[18]  A PEO is an organization, other than an organization included in standard industrial code (SIC) 736, that provides management and administration of human resources of another entity.[19]

Example 4. ABC Co. enters into a contract with PEO Co. whereby all of ABC Co.’s officers and employees become employees of PEO Co.  The former ABC Co. employees continue to perform the same tasks for ABC Co. although they are paid by PEO Co. for these services.

The compensation paid by PEO Co. will be included in the compensation calculations used to determine if ABC Co. qualifies for the SBAC.

The compensation and allocated income disqualifiers in conjunction with the definition of compensation provide that the entire compensation paid or accrued for the benefit of employees, officers or directors must be included in compensation for purposes of determining disqualification.[20]  The statute does not limit compensation to only the compensation that relates to the performance of services benefiting an entity or compensation paid by a specific taxpayer.  Rather, the Act looks to the total compensation of the shareholder or officer.[21]  The statute has set a threshold amount of compensation at $180,000 for shareholders and officers.  The statute does not contemplate or allow taxpayers to manipulate officer compensation by allocating compensation between member entities that the officers serve so that the amounts are below the threshold set by the Legislature.

Example 5. Audrey, Bailey, and Olivia are officers of XYZ Co. and 123 Co., both members of a UBG.  All three devote approximately 50% of their time to each company.  Audrey receives compensation of $100,000 from each company.  Bailey and Olivia are each paid $200,000 by 123 Co.

When determining the SBAC compensation disqualifier for both companies, each officer’s compensation exceeds the $180,000 threshold and the companies are disqualified from the credit.  XYZ Co. may not rely on the fact that Bailey’s and Olivia’s salaries were paid by 123 Co.  Further, XYZ Co. may not limit Audrey’s compensation to the percentage of time she dedicated to it or limit her salary to the amount it paid.  Similarly, 123 Co. may not reduce the salary it paid Bailey and Olivia based on the percentage of time they dedicate to it or limit Audrey’s compensation to the amount it paid.

Credit Reducers:

Allocated Income and Compensation Reducers

The SBAC is reduced on a percentage basis if a shareholder’s or officer’s compensation and directors’ fees or a shareholder’s allocated income exceeds $160,000.  The credit completely phases out once these amounts exceed $180,000.[22] 

DISQUALIFIER CHART

The reduction is based on the officer or shareholder with the greatest amount of compensation or allocated income.[23]

Example 6. Harper and Mina are shareholders in XYZ Co.  Harper has a 97% ownership interest and Mina has a 3% interest.  XYZ Co.’s modified business income less loss adjustment is $100,000.  Harper’s compensation is $75,000.  Mina’s compensation is $160,000.

Harper’s allocated income is $97,000 + $75,000 = $172,000.   Eligible for 40% of credit.

Mina’s allocated income is $3,000 + $160,000 = $163,000.  Eligible for 80% of credit.

Because Harper’s disqualifier amount is higher than Mina’s, XYZ Co. will only be entitled to a 40% credit.

Gross Receipts Reducer

A taxpayer that has gross receipts that exceed $19,000,000 up to $20,000,000 will have its SBAC reduced proportionally based on a statutory formula.  Gross receipts more than $20,000,000 disqualify the taxpayer from the credit.  Further, the credit may not exceed the tax liability.[24]

Example 7. C Corp has gross receipts of $19,250,000 and otherwise qualifies for the SBAC.  C Corp’s SBAC will be reduced 25% as follows:

Excess gross receipts over $19,000,000                   $ 250,000/

Statutory Denominator                                               $1,000,000

Reduction to credit                                                     25%

Assume C Corp’s reduced credit is $28,000.  Tax liability is $24,365.  C Corp will only be allowed to claim a SBAC of $24,365 even though the reduced credit was higher than its tax liability. The excess credit amount of $3,635 may not be carried forward.

Special Considerations:

Shareholders, Active Shareholders and Officers

When computing the SBAC it is important to identify shareholders, active shareholders and officers as these terms are not interchangeable and must be specifically applied when calculating credit qualification, credit reduction, ABI etc.

Compensation or allocated income of a shareholder must not exceed $180,000.00.  A shareholder is a person who owns outstanding stock in a corporation or is a member of a business entity that files as a corporation for federal income tax purposes. An individual may be the direct or indirect owner of stock, or the equity interest in a business entity that files as a corporation for federal income tax purposes, through application of IRC 318(a)(1).[25]

Outstanding stock means all stock of record, regardless of class, value, or voting rights.  Treasury stock is not considered outstanding stock and is therefore excluded.  Members of a limited liability company electing to file as a corporation are treated as shareholders consistent with their equity interest in the entity.  Stock ownership may be direct or indirect, including shares owned by family members as defined by the attribution rules under IRC 318(a)(1).  Family members include spouses, parents, children, and grandchildren. The attribution rules do not distinguish between adult and minor children.  There is no attribution between siblings. 

Example 8. The Xi family are shareholders in XYZ Co.  Husband directly owns 40%, wife owns 10%, son owns 20% and daughter owns the remaining 30%.

Applying the attribution rules of IRC 318, Husband indirectly owns the shares of his wife and children or 100% of XYZ Co.  Similarly, wife directly and indirectly owns 100% of XYZ Co.

Son is attributed his parents’ shares in addition to the 20% he directly owns for a total ownership interest of 70%.  Likewise, daughter has an 80% ownership interest.

Active shareholders are a subset of shareholders who must own at least 5% of the outstanding stock or other ownership interest in the corporation and who receive at least $10,000 in compensation, directors’ fees, or dividends from the business.[26]

Thus, all active shareholders are shareholders but not all shareholders are active shareholders.  This distinction is important as the statute makes specific reference to each type of shareholder.  When the statute refers to “shareholder,” all shareholders, including active shareholders, must be considered.  When “active shareholder” is referenced, only those shareholders meeting the definitional requirements specified in MCL 206.671(9)(a) are considered.  For example, the compensation disqualifier and compensation reduction limits discussed above refer to the broader term “shareholder.”  In contrast, the ABI disqualifier calculation only considers the compensation and directors’ fees addback of “active shareholders.”

Also, for purposes of determining excess allocated income disqualification, the statute provides that an active shareholder’s share of business income may not be attributed to another active shareholder.[27]

Example 9. Bryan and Jo Ann are husband and wife.  Both are active shareholders in 123 Co.  Bryan has compensation of $30,000 and his share of modified business income is $80,000.  Jo Ann has compensation of $50,000 and modified business income of $120,000.

Although IRC 318 attribution rules are applicable for determining stock ownership between a husband and wife for purposes of determining credit disqualification under the shareholder allocated income disqualifier, the business income allocated to each active shareholder may not be attributed from Bryan to Jo Ann or vise-versa.

Bryan’s allocated income is $110,000; Jo Ann’s is $170,000.  123 Co. will not be disqualified from the SBAC; however, the credit will be reduced by 60% because Jo Ann’s allocated income is $170,000. 

Officer compensation must not exceed $180,000.00.  Under the Michigan Business Corporation Act, the officers of a corporation shall consist of a president, secretary, treasurer, and, if desired, a chairperson of the board, 1 or more vice-presidents, and such other officers as may be prescribed by the bylaws or determined by the board.[28]

The CIT similarly defines officer but broadens the definition to include persons performing duties and responsibilities similar to chairperson of the board, president, vice president, secretary or treasurer that include, at a minimum, making major decisions.[29]  Whether a person performs duties like an officer or makes major decisions, and is considered an officer, is determined on a facts and circumstances basis.  Managers of an LLC taxed as a corporation will be presumed to perform duties similar to officers.  All persons deemed to be officers must be considered when determining compensation for credit disqualification or credit reduction purposes.

An individual who is both an officer and shareholder will only include total compensation once in determining the credit disqualifiers or reduction to the credit.  Total compensation is the entire amount received by the individual who is determined to be a shareholder or officer.  Compensation is not limited to amounts paid for a job title or function but is all compensation received from the taxpayer in the tax year.  Shareholders and officers should report the required information on Form 4894, Corporate Income Tax (CIT) Schedule of Shareholders and Officers, to determine eligibility for the SBAC.  A completed Form 4894 must be filed as part of a completed return.

UBG Considerations

The definition of “taxpayer” under the CIT includes a UBG.[30]  Thus, in the situation where a UBG exists, the SBAC is available to the UBG and not each member comprising the UBG.  However, if a disqualifier or credit reduction percentage applies to any one member of the group, the entire UBG is disqualified or the credit is reduced.[31]

UBGs compute the gross receipts and ABI disqualifiers at the UBG level.  In other words, the gross receipts and ABI of the UBG is the sum of the gross receipts and ABIs of each member of the UBG.  Members should compute gross receipts and business income used in the calculation of the disqualifier consistent with the accounting method used for federal income taxes.  For years prior to December 31, 2013, under the statute, UBGs were not able to eliminate intercompany transactions when computing gross receipts for purposes of the gross receipts disqualifier.  2014 PA 14 changed this for years after December 31, 2013.[32]  Intercompany eliminations, however, were always an adjustment to business income when computing the CIT tax base.  Business income is the starting point for computing ABI and, therefore, intercompany eliminations were accounted for in the calculation of ABI.  Because of PA 14, gross receipts and the ABI disqualifiers are now both computed after intercompany eliminations.

When considering the compensation and allocated income disqualifiers, an officer or shareholder’s compensation and allocated income is calculated by combining all amounts paid to the officer or shareholder by all members of the UBG.[33]

Example 10. Taxpayer, UBG Co., is comprised of three members, 1Co., 2Co. and 3Co. It has no loss adjustment available. A shareholder for 1Co. received allocated income (compensation and modified business income after loss adjustment) of $120,000.  A shareholder of 2Co. received allocated income of $150,000. A shareholder of 3Co. received allocated income of $150,000 from 3Co. and received directors’ fees of $20,000 from both 1Co. and 2Co.

Because the shareholder for 3Co. received total allocated income after loss adjustment of $190,000, the UBG is disqualified from claiming the SBAC.

Example 11. Same facts as in Example 10, except that the shareholder of 3Co. received compensation and modified business income after loss adjustment of $122,000 from 3Co., making that shareholder’s total allocated income paid by all members of the group $162,000.   

The UBG’s credit is reduced by 20% because the compensation, directors’ fees, and modified business income after loss adjustment (allocated income) exceeds $160,000 but is less than $165,000.

Loss Adjustment for UBG ABI

The loss adjustment is used to reduce ABI and shareholder allocated income to either qualify a UBG for the SBAC or minimize the allocated income reduction percentages. The loss adjustment is not available to reduce gross receipts for purposes of the gross receipts disqualifier to qualify a UBG for a full or reduced credit.  UBG ABI is calculated by combining the ABI amounts of all members. Total UBG ABI after loss adjustment that exceeds $1,300,000, adjusted for inflation to the tax year using the Detroit consumer price index, will disqualify the group from claiming the credit.  Just like with individual taxpayers, the loss adjustment is used to reduce the taxpayer group’s ABI below the annual disqualifier amount.  Available losses are used by the UBG on a FIFO method until the losses are used up or are extinguished.  The amount of loss adjustment used to qualify a UBG for the SBAC or minimize a reduction may not be used in subsequent years; however, the UBG’s remaining loss adjustment is available for use in subsequent tax years.

To reduce the UBG’s ABI for purposes of the disqualifier, the loss adjustment is calculated on a group level.  Available losses incurred in the immediate prior five tax years in which the SBAC was received by the taxpayer may be used to reduce the current tax year’s ABI.  Members that were not part of the current UBG when the member incurred a qualifying loss may bring unused qualifying losses to the UBG for usage.  Any member’s loss adjustment remaining will be available to that entity in the event it leaves the UBG.  If a departing member did not contribute to the available loss remaining at the time of departure, the departing member is not entitled to take any loss with it.[34]  Members should track loss adjustment balances.

Example 12. Assume the annual ABI disqualifier, adjusted for the Detroit consumer price index for the current year, is $1,350,000.  UBG, ABC Co., has two members XYZ Co. and 123 Co.  Member XYZ Co. has ABI before loss adjustment of $1,200,000 and a loss of $60,000 from 5 years ago and a loss of $20,000 from 4 years ago.  Member 123 Co. has ABI before loss of $200,000 and a loss of $5,000 from 4 years ago.  Both members received the SBAC in the previous years the losses were incurred.

Total group ABI before the loss adjustment is $1,400,000 and exceeds the indexed ABI disqualifier by $50,000.  Applying the FIFO method, ABC Co. may use $50,000 of XYZ Co.’s loss from 5 years ago to reduce the group ABI to the indexed limit amount. 

The remaining amount of XYZ Co.’s loss, $10,000, will be extinguished and unavailable for future years because it will fall outside the 5 year look back period.  Next year, the UBG will have $25,000 of loss available from both members to reduce ABI.  This available loss will be the oldest and first loss used under the FIFO method as it will fall within year 5 of the look back period.  Any of this available loss not used will be extinguished as it will exceed the 5 year look back period for subsequent tax years.

Members that are new to a UBG may bring business loss carryforwards to the group.  These losses will be used with losses generated by other members of the group during the five previous tax periods.  The group will use the oldest available business loss first.  If members create business loss of the same age and the loss available exceeds the loss needed to reduce ABI, the Department will presume the loss of any member will be used in proportion to the loss each member created or brought to the group.  Any member’s balances not used will be carried forward.

Example 13. UBG Member 1 joined the UBG in the current tax year.  Member 1 brings a tax loss of $10,000 that is 5 years old and a $5,000 tax loss that is 4 years old.  Both losses qualify since Member 1 received the SBAC in both prior tax years.  During the current year, Member 1 created a loss of $30,000 and Member 2 created a loss of $10,000.  Assume the UBG otherwise qualifies for the SBAC except the UBG’s ABI is over the current year’s indexed disqualifier threshold by $25,000.

To reduce its ABI for purposes of the disqualifier, the UBG will first apply Member 1’s $10,000 loss from 5 years ago and then the $5,000 loss from 4 years ago.  The remaining $10,000 loss will be used proportionally from both Member 1 and Member 2’s current year losses.  Because Member 1 generated $30,000 of the group’s total current year loss of $40,000 (75%), the remaining $10,000 loss, will be applied on a pro rata basis using $7,500 of  Member 1’s loss and $2,500 of Member 2’s loss.

If either Member 1 or Member 2 leave the UBG, it would respectively take $22,500 or $7,500 of remaining loss with it.  Members must keep track of remaining loss carryforwards.

Loss Adjustment for Allocated Income

The use of loss adjustments in computing ABI for purposes of the disqualifier does not affect the loss adjustment available for computing shareholder allocated income.  Loss adjustments for the ABI disqualifier and the shareholder allocated income disqualifier are computed independently of each other.  Therefore, it is likely that the loss available for each disqualifier will have different balances and should be tracked by taxpayers.  If any member has a shareholder with compensation, directors’ fees and allocated income that exceeds $180,000 after loss adjustment, the UBG is disqualified from the SBAC.  All compensation and business income allocated to a shareholder from members of the UBG must be considered in computing allocated income for purposes of the disqualifier.  The loss adjustment required is the amount needed to reduce each shareholder’s allocated income to $160,000 to qualify for the full SBAC or to between $160,001 and $180,000 to receive a reduced credit. Further, the loss adjustment is only available to reduce the shareholder’s share of modified business income.  The reduced credit will be determined based on the largest officer compensation or shareholder allocated income calculation.  Loss adjustments are computed on Form 4895, CIT Loss Adjustment for the Small Business Alternative Credit.  A worksheet is available to calculate loss adjustment for shareholders that have allocated business income from multiple members.

Example 14. Margaret and Julie are shareholders in a three-member UBG.  All three members pay Margaret and Julie wages.  Margaret’s total compensation from all members is $183,000 and Julie’s compensation is $125,000.  The UBG has losses of $50,000 available for a loss adjustment. Margaret received $10,000 as her share of modified business income from the three members and Julie received $50,000.

Total allocated income before loss adjustment for Margaret is $193,000 and Julie’s allocated income before loss adjustment is $175,000.  Although Julie’s allocated income is below the allocated income disqualifier amount, the loss adjustment must be applied to Margaret’s allocated income because it is higher.  Because Margaret received $10,000 as her share of modified business income, $10,000 of the $50,000 available loss can be used against Margaret’s modified business income to reduce her total allocated income to $183,000.  Since Margaret’s adjusted allocated income after loss adjustment exceeds the $180,000 disqualifier limitation amount, the UBG does not qualify for the SBAC.

Short Years

If the tax year reported is less than 12 months, gross receipts, ABI, and allocated income must be calculated on an annualized basis to determine eligibility for the credit or a reduced credit.  Generally, a business counts a month when the business operates for more than half the days of the month.  If the tax year is less than one month, use one month for the purposes of annualizing.  To annualize gross receipts, or ABI and allocated income, multiply the amount by 12 and divide the result by the number of months of gross receipts being reported, or the months the person was compensated, and served as an officer or owned shares, respectively.

Example 15. ABC Co. is filing its first return and reporting a nine-month tax period.  Gross receipts for this period are $14,375,000.

ABC Co.’s annualized gross receipts are determined as follows:

$14,375,000 x 12/9 = $19,166,666.  Because the gross receipts are greater than $19,000,000 but less than $20,000,000, ABC Co. will qualify for a reduced credit limited to its tax liability assuming it otherwise qualifies for the credit.

Annualized amounts are only used for computing and applying disqualifiers.  Actual amounts are used for the actual credit calculation. Shareholders that owned stock in a corporation for less than the entire tax year, or persons that served as an officer for less than the entire year, must annualize business income and compensation when computing and applying disqualifiers.  The calculation is the same as described above.