The Federal Income Tax "Tax Benefit Rule" Is Incorporated into the Michigan Income Tax Act But Not Applicable
In Sturrus v. Department of Treasury, Michigan Court of Appeals, No. 295403, February 8, 2011 the Michigan Court of Appeals has held that the federal tax benefit rule is incorporated into personal income tax law, but that it was not applicable to the taxpayers' case. According to the federal tax benefit rule, gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent that such amount did not reduce the amount of tax imposed.
The taxpayers' case arose from making investments in a company that was later found to be a Ponzi scheme. In 2002, the taxpayers claimed a theft loss deduction on the federal tax return. This deduction was "below the line," i.e., after the calculation of adjusted gross income (AGI), so it did not reduce the Michigan tax liability. The company entered bankruptcy and the taxpayers offset the repayment of interest received from the investment against the lost investments in the company to the bankruptcy trustee. In 2004, the taxpayers reported a theft loss recovery on the federal tax return. This item was "above the line," i.e., before the calculation of AGI, so it was essentially included on the Michigan tax return. As a result, the taxpayers deducted the theft loss recovery from the 2004 Michigan return. The tax benefit rule did not permit this as the lost investment was not previously deducted on any Michigan return. The court noted that while Michigan does not have a theft loss deduction, the proper place to seek a remedy was in the Legislature.