Internal Policy Directive 2004-9

INTERNAL POLICY DIRECTIVE 2004-9

December 27, 2004

SINGLE BUSINESS TAX Calculation of a tax liability when special tax base and apportionment provisions apply to one, but not all, entities filing a single SBT return

POLICY ISSUE

What is the correct method to calculate the Single Business Tax (SBT) liability of an entity and its disregarded subsidiary(s) when special tax base and apportionment provisions apply to one, but not all, entities filing a single SBT return? Must the entity and its subsidiary compute the apportioned tax base separately, combine their apportioned tax bases, and then apply the remaining elements (business losses, Capital Acquisition Deduction Recapture (CADR), reductions, and credits) on a combined basis? Or must the entities compute their tax liabilities separately also?

POLICY DETERMINATION

When special tax base and apportionment provisions apply to one, but not all, entities filing a single SBT return, the tax base should be calculated separately and apportioned separately. The separately calculated apportioned tax bases must then be added and the balance of the return calculated on the total. If the calculation of a component of the return involves separate requirements, e.g., the calculation of the CADR or the ITC, these components should be calculated separately and the net result included in the total calculation. The net credit would then be available to offset the total liability.

DISCUSSION

Revenue Administrative Bulletin 2000-5, Michigan Tax Treatment of Federal Qualified Subchapter S Subsidiary (QSUB) Election, addresses this issue.

"The QSub treatment applies to an S corporation and its QSub(s) even when all are not subject to the same tax base or apportionment calculations. However, the special tax base and apportionment provisions that apply to one, but not all, must be applied on a separate entity basis." (emphasis added)

"However, the SBTA provides specific tax base provisions for insurance companies, financial organizations, and nonprofit entities. There are special apportionment provisions for insurance companies, financial organizations and transportation companies. Further, certain nonprofit organizations or activities are exempt from the tax. If an S corporation and its QSub(s) are subject to different tax base provisions, apportionment calculations, or exemptions, the specific SBT provisions must be applied separately to the parent and the subsidiary. This ensures that QSub SBT treatment is compatible with the special formulas or exemptions." (emphasis added)

"EXAMPLE

S corporation, X, is a bank that owns Y, a corporation that is not a bank or financial organization. X makes a federal election to treat Y as a QSub. X must compute its SBT base under MCL 208.21 and Y’s tax base under MCL 208.9. The financial organization apportionment calculation applies to X while the provisions under MCL 208.46 – 208.53 apply to Y. This is consistent with federal treatment of special IRC sections and maintains the specific provisions of the SBTA."

This same treatment would apply to the single SBT filing made by a taxpayer and its wholly owned disregarded subsidiary pursuant to federal entity classification election regulations (check the box), even though RAB 1999-9, Effect of Federal Entity Classification Election on Michigan Taxes, is silent in this regard.

Following is a discussion of two alternative methods that have been suggested to achieve the desired result and their drawbacks. Neither of these methods will be adopted in their entirety.

Method #1: When a taxpayer has mixed business activity subject to different apportionment or tax base provisions, e.g. transportation and non-transportation activities, the tax base could be calculated separately and apportioned separately. The separately calculated apportioned tax bases could then be added and the balance of the return calculated on the total. This may occur within a company between divisions, or may more likely occur when a disregarded entity is treated as a division of its parent.

 

Method #1 Example

Parent

Disregarded Sub

Combined

Tax Base

$100,000

$50,000

N/A

Apportioned Tax Base

$10,000

$5,000

$15,000

CAD Recapture*

N/A

N/A

$5,000

Tax Base

N/A

N/A

$20,000

Tax before ITC

N/A

N/A

$380

ITC*

N/A

N/A

$280

Tax after Credits

N/A

N/A

$100

 

* In reality, Method #1 is over simplified. The calculation of both the CAD recapture and the ITC require the employment of an apportionment percentage. There is no avenue to completely calculate these items on a combined basis.

Method #2: When a taxpayer has mixed business activity subject to different apportionment or tax base provisions, the tax base, tax liability and any credits could be calculated separately and then the tax after credits combined to yield the tax reported on the taxpayer’s return.

 

Method #2 Example

Parent

Disregarded Sub

Combined

Tax Base

$100,000

$50,000

N/A

Apportioned Tax Base

$10,000

$5,000

N/A

CAD Recapture

$2,000

$3,000

N/A

Tax Base

$12,000

$8,000

N/A

Tax before ITC

$228

$152

N/A

ITC

$0

$280

N/A

Tax after Credits

$228

$0

$228

 

This method presents its own set of problems. If a CADR or ITC are calculated separately and applied separately, you may have a tax liability for one division, none for the division that takes the ITC, and a carry forward of the credit to future years, as shown in the example above. In addition, if a statutory exemption or small business credit are calculated on a separate basis, you may reach very different results than if they are calculated on a combined basis. Also, a business loss applied separately might offset the tax base of one division but not the other, leading to a tax liability and a loss carry forward in the same tax year.

The Department will adopt a compromise between the two methods. The tax base should be calculated separately and apportioned separately. The separately calculated apportioned tax bases should then be added and the balance of the return calculated on the total. If the calculation of a component of the return involves separate requirements, e.g., the calculation of the CADR or the ITC, these components will be calculated separately and the net result included in the total calculation. A net credit would then be available to offset the total liability. This alternative corrects the flaws identified in the first two methods suggested.

This option allows the taxpayer to be treated as one entity, except in those areas where separate statutory requirements apply, consistent with RAB 1999-9 and 2000-5 treatment of disregarded entities.

The following example illustrates this treatment. Company A is a financial organization subject to the single business tax. Company A is the sole member of a single member limited liability company, LLC B, whose business activity consists of the leasing of both real and tangible personal property. LLC B has chosen to be disregarded for federal income tax purposes, and will be treated as a division of Company A on both their federal and SBT tax returns. Company A, as a financial organization, must calculate its tax base according to the adjustments found in MCL 208.21 and its apportionment as provided in MCL 208.65. LLC B, as a non-financial entity, must calculate its tax base using the standard tax base methodology found in MCL 208.9 and its apportionment using the standard three-factor formula provided in MCL 208.45.

Final Example

a. Company A

b. LLC B

c. Combined

1. Tax Base

$100,000 (Incl. §21 adj.)

$50,000 (Incl. §9 adj.)

N/A

2. Apportioned Tax Base

$10,000 (Employing §65.)

$7,000 (Employing §45.)

$17,000 (Sum of 2a & 2b)

3. CAD Recapture

$2,000 (Employing §65.)

$3,000 (Employing §45.)

$5,000 (Sum of 3a & 3b)

4. Adj. Tax Base

N/A

N/A

$22,000 (Sum of 2c & 3c)

5. Tax before ITC

N/A

N/A

$418 (4c times tax rate)

6. ITC

$0 (Employing §65.)

$280 (Employing §45.)

$280 (Sum of 6a & 6b)

7. Tax after Credits

N/A

N/A

$138 (5c less 6c)

 

Any business loss, statutory exemption, or reduction to adjusted tax base would be calculated on a combined basis.

Note: This example is not all-inclusive. In each situation all relevant facts and circumstances must be examined to determine proper treatment.

Components affected:

  • Tax base*
  • Apportioned tax base*
  • CADR*
  • Business Loss*
  • Statutory Exemption*
  • Reduction to adjusted tax base*
  • Tax before credits*
  • ITC
  • Small business credit*
  • Contribution credits*
  • Unincorporated credit*
  • Nonrefundable credits
  • Refundable credits

* Existed prior to the inception of the ITC

Tax base and apportionment provisions that could come into play:

  • Financial organization tax base and apportionment
  • Transportation services apportionment
  • Insurance company calculation and apportionment