Revenue Administrative Bulletin 1989-51

Approved: June 2, 1989

 

SINGLE BUSINESS TAX - SMALL BUSINESS CREDIT AND STATUTORY EXEMPTION FOR PART-YEAR SHAREHOLDERS/PARTNERS

(Replaces Single Business Tax Bulletin 1978-4)

RAB-89-51. The purpose of this Bulletin is to provide examples of how to compute the small business credit and statutory exemption when a shareholder/partner does not have ownership in the entity for the entire year.

Statutory Exemption

An S corporation, professional corporation, or partnership is allowed an increased exemption of $12,000 for each "qualified" shareholder or partner. [MCL 208.35(1)] The increased exemption is available for "qualified" shareholders/ partners who meet the following conditions:

  1. Must be a full-time employee of the taxpayer.
     
  2. Must have business income from the business of at least $12,000.
     
  3. Must own (without attribution) at least 10% of that business.

The increased exemption is equal to the number of "qualified" shareholders/partners in excess of one (e.g., for a corporation with four "qualified" shareholders, three may be used to increase the exemption). The total increased exemption cannot exceed $48,000.

The statutory exemption (including the increased exemption above) is phased out at the rate of $2 for each $1 that business income exceeds the total statutory exemption. For purposes of this exemption, business income [MCL 208.3(3)] means business income plus the compensation and director's fees of ALL shareholders, plus any carryback/forward of net operating or capital losses to the extent deducted in arriving at federal taxable income. [MCL 208.35(l)(a)]

Small Business Credit

This credit is available to all small business entities meeting specific criteria. One of these criteria is that the business must include in adjusted business income the compensation and director fee of "active shareholders."

An "active shareholder" is one who receives, in any combination, at least $10,000 in compensation, director's fees, or dividends from the business, and who owns at least 5% of the outstanding stock. A shareholder means a person as defined in MCL 208.6(1) who owns outstanding stock in the business. [MCL 208.36(l)(d)] An individual shall be considered as owning stock directly or indirectly, by or for family members as defined by section 318(a)(1) of the Internal Revenue Code. [MCL 208.36(l)(d)]

Examples of Calculating the Above Statutory Exemption and
Small Business Credit for Part-Year Shareholders/Partners

The examples on pages 4 and 5 demonstrate the necessary calculations when a shareholder/partner has ownership in the entity for less than an entire taxable year. In these examples the term "qualified shareholder" refers to the calculation for the increased statutory exemption. The term "active shareholder" refers to the calculation of whether a shareholder shall be considered "active" for purposes of determining the small business credit. A glossary of terms follows to assist in understanding the terms used in the examples.

GLOSSARY OF TERMS

Active Shareholder. An "active shareholder" as referred to in MCL 208.36(l) is one "who receives at least $10,000 in compensation, director's fees, or dividends from the business, and who owns at least 5% of the outstanding stock." Note: A person CAN be an "active shareholder" in more than one corporation.

Allocated Income. For regular corporations allocated income means (on an annual basis) shareholder income (see definition) and/or the sum of shareholder income plus the shareholder's share of business income. Allocated income of shareholders of S corporations or partners of partnerships means (on an annual basis) the sum of shareholder's/partner's income plus the shareholder's/partner's share of business income.

Annualization. To annualize, multiply the amount from the short-period by 12, and then divide the result by the number of months included on the short-period return.

Attributed Ownership. Internal Revenue Code section 318(a)(1) establishes the criteria for determining constructive ownership (attribution) of stock between family members. This regulation is used pursuant to MCL 208.36(l)(d), and it is effective for all tax years starting on or after 1/l/84.

Disqualified Entity. An entity is disqualified from the small business credit if ANY partner of a partnership or shareholder of an S corporation has allocated income (see definition) from the entity in excess of $60,000 for tax years starting 1/l/77 and ending prior to 1/l/84.

A corporation other than an S corporation is disqualified if any shareholder or officer has allocated income (see definition) from the entity in excess of $60,000 for tax years starting 1/l/77 and ending prior to 1/l/84.

Note: The disqualifying amount was increased to $90,000 for tax years starting on or after 1/1/84 and further increased to $95,000 for tax years starting on or after 1/l/85. (See MCL 208.36(2)(a), (b).)

Officer. Officer means an officer of a corporation (other than an S corporation) and includes the chairperson of the board, president, vice-president, secretary, and treasurer, and persons performing similar duties. Part-year officers shall annualize their compensation and director's fees for purposes of determining the income disqualifiers for the small business credit.

Outstanding Stock. Outstanding stock means all stock of record, regardless of class, value, or voting rights, but outstanding stock does not include treasury stock.

Overlapping Qualifications

  1. Increased Statutory Exemption. Because one of the requirements for a "qualified" shareholder or partner is that the individual must be a full-time employee of the taxpayer, an individual can NOT have "overlapping qualifications" in more than one entity. [MCL 208.35(a)(a)]
     
  2. Small Business Credit. A person CAN be an active shareholder in more than one corporation.

Part-year Shareholder. A part-year shareholder is a person who owns stock of a corporation for a period of less than 12 months. Part-year shareholders must prorate the stock owned on the last day on which they owned such stock during the corporation's tax year.

Person. A person is defined in MCL 208.6(l) and "means an individual, firm, bank, financial institution, limited partnership, copartnership, partnership, joint venture, association, corporation, receiver, estate, trust, or any other group or combination acting as a unit."

Proration. To prorate: multiply the amount from the short-period return by the number of months on the short-period return, and then divide the result by 12.

Qualified Shareholder or Partner. This term refers to a shareholder or partner meeting specific criteria for the increased statutory exemption found in MCL 208.35(l)(a). Although the term "qualified" shareholder or partner is not used in the Single Business Tax Act, the term is descriptive and it is used in the instruction books and on form C-8000.

Shareholder. A "shareholder" means a person, as defined [MCL 208.6(1)], who owns outstanding stock in the business. An individual shall be considered as owning the stock owned, directly or indirectly, by or for family members as defined by section 318(a)(1) of the [I]nternal [R]evenue [C]ode. MCL 208.36(l)(d). To be a shareholder, a person must be a record holder of a share of stock of a corporation on any day during the corporation's taxable year.

Shareholder/Partner Income. Shareholder or partner income means compensation and director fees attributed to any person during the period that such person has ownership in the entity. Compensation includes wages, payroll taxes, and other payments made for the benefit of the shareholder or partner.

EXAMPLE 1

An S corporation had 10,000 shares of outstanding stock during its calendar year 1987 and business income of $10,000. On April 1, 1987 there was a transfer of 2,000 shares of stock from Shareholder A to Shareholder B. Shareholders A and B were full-time employees during the period they had stock ownership.

  Shareholder A Shareholder B
Shareholder facts: Jan./March Apr./Dec. Jan./March Apr./Dec.
         
Shares of stock owned 2,000 -0- -0- 2,000
1. Compensation $5,000 -0- $6,000 $15,000
2. Dividends $1,000 -0- -0- $3,000
3. Share of business income $500 -0- -0- $1,500
($10,000 x % stock below)  
         
Qualifications:        
Percentage of stock   20% x 3/12 = 5% 20% x 9/12 = 15%
         
Income qualifications:          
Qualified   [(1 x 12/3 ) + 3] = $20,500 [(1 x 12/9) + 3] = $21,500
Active   [(1 + 2) x 12/3] = $24,000 [(1 + 2) x 12/9] = $24,000
           
Allocated income credit disqualifier for small business credit: [(1 x 12/3) + 3] = $20,500 [(1 x 12/9) + 3] = $21,500
           
Comments:          
           
Both Shareholders A and B satisfy the qualifications for "active" shareholders and neither disqualify the corporation from the small business credit. Since shareholder A's prorated percentage of stock is less than 10%, there is only one qualified shareholder (Shareholder B) and no additional exemption.

EXAMPLE 2

A regular corporation for its calendar year 1987 had business income of $40,000 and 10,000 shares of outstanding stock. For the period of January through September of 1987, Shareholders A and B each owned 5,000 shares of stock. On October 1 the stock of A was transferred to Shareholder C. Shareholders A, B and C were full-time employees during the period they had stock ownership.

  Shareholder A Shareholder B Shareholder C
Shareholder facts: Jan./Sept. Oct./Dec Jan./Dec. Jan./Sept. Oct./Dec.
       
Shares of stock owned 5,000 -0- 5,000 -0- 5,000
1. Compensation $20,000 $15,000 $30,000 -0- $10,000
2. Director fees $1,000 $2,000 $1,500 -0- $500
3. Dividends $1,000 -0- $1,500 -0- $500
4. Share of business income $15,000 -0- 20,000 -0- $5,000
($40,000 x % of stock below)    
       
Qualifications:      
Percentage of stock 50% x 9/12 = 37.5% 50% 50% x 3/12 = 12.5%
       
Income qualifications:      
Qualified [(1 + 2) x 12/9] + 4 = $43,000 [1 + 2 + 4] = $51,500 [(1 + 2) x 12/3] + 4 = $47,000
Active [(1 + 2 + 3) x 12/9] = $29,333 [1 + 2 + 3] = $33,000 [(1 + 2 + 3) x 12/3] = $44,000
       
Allocated income credit dis-      
qualifier for small business [(1 + 2) x 12/9] + 4 = $43,000 [1 + 2 + 4] = $51,000 [(1 + 2 ) x 12/3] + 4 = $47,000
credit: or [(1 + 2) x 12/9] = $28,000 or [1 + 2] = $31,500 or [(1 + 2 ) x 12/3] = $42,000
           
Shareholder income for          
statutory exemption phaseout        
(not including dividends): [1 + 2] = $21, 000 [1 + 2] = $31,500 [1 + 2] = $10, 500
           
Comments:          
           
The statutory exemption of $40,000 is completely phased out by the business income of $40,000 plus shareholder income of $63, 000. Had this corporation been an S corporation or professional corporation, there would be three qualified shareholders resulting in two additional exemptions of $12, 000 each. The increased exemption of $64, 000 ($40, 000 + $24, 000) would still be phased out by the $103, 000 ($40,000 + $63,000) of business and shareholder income.
       
For this regular corporation, the allocated income credit disqualifiers are below the $95,000 limit for each shareholder. All shareholders are active shareholders for small business credit. The adjusted business income used in the credit computation is $40,000 plus active shareholder income of $63,000.