The Single Business tax is basically a value added tax computed primarily on federal taxable income derived from a "business activity" plus compensation, depreciation expense, and interest expenses, less the cost of capital assets acquired in a tax year.
What is the Single Business Tax?
The Michigan Single Business Tax effective January 1, 1976, differs from any tax used in the United States. Unlike taxes on the sale of an item or service, or on receipt of certain types of income or ownership of assets, the Single Business Tax is specifically designed for the modern, industrial, market economy. Current taxes evolved from customs of the pre-industrial age. Sales, receipt and assets were a convenient and equitable means to apportion tax burden. However, our modern industrial society both permits and requires a tax system compatible with the market economy technology created. The Single Business Tax is a type of value-added, developed since World War II to tax a business without interfering with internal business decisions and is based solely on economic criteria. This tax was adopted, but never used, by Japan in the late 1940s.
Michigan's Business Activities Tax (1953-1967) was an incomplete value-added tax. The European Common Market adopted a value-added tax in the 1960s and it has spread to many countries. The key feature of the Single Business Tax is that the liability of the business is proportional to economic size. The tax applies equally to every business and the amount of tax is independent of legal form, nature of business and particular production or financing means chosen by the business.
In contrast, the taxes that were repealed were clearly not neutral in impact and were necessarily elements in internal business decision-making. The franchise tax, for example applied only to corporations, but was significant only for a few heavy manufacturing and utility industries. The inventory tax was significant only in retailing, wholesaling and integrated manufacturing. As a practical matter, profits tax applied only to large corporation, and the amount of tax due depended upon the firm's accounting practices. All taxes that were replaced created a distinction between course of action for that which was most economically efficient, and most beneficial for society. The Single Business Tax largely eliminates these distinctions. Although federal tax considerations are still of importance, a first step has been taken to free business from being forced to make uneconomic decisions in order to minimize tax liability.
The Single Business Tax is administered like the corporate income tax, relying on information from the federal income tax return, and also using established IRS definitions and tax dates. The tax is imposed on the sum of profits (or losses), payroll and fringe benefits net interest paid and depreciation, less capital expenditures. This sum represents economic size of each business and is the same type of calculation used to add up Gross National Products for the U.S. The sum is also equal to the amount of income paid by each business to make products or services. The tax base is the sum of payments to owners (profits, interest and depreciation) and employees (wages and fringe benefits). Thus, the tax base for each business is proportional to the economic size. The tax base could be equivalently calculated, as with all other value-added taxes, as gross sales less the cost of goods or services purchased from other taxable firms. This method does not permit piggybacking on the federal tax system, and would require a separate administrative apparatus. The Michigan Single Business Tax does permit a few deviations from the tax based described above to minimize changes in tax liability that would otherwise occur. Special provisions are included for labor intensive service firms, and firms that operate with little capital equipment.
The impact of the Single Business Tax is the effect of new tax netted against the features of the taxes repealed. The following consequences were expected:
All the taxes repealed were taxes on capital as opposed to labor inputs into business. Since the Single Business Tax treats capital and labor identically, the heavy burden of taxation on capital is lessened, encouraging jobs and creating the industrial investments.
More stable state revenue from business:
The yields from the Single Business Tax will closely parallel the course of economy, whereas the old taxes dropped sharply in recession periods and expanded rapidly during economic recovery. There will be less likelihood of the budget deficits followed by periods of hastily spent surpluses that Michigan experienced in recent years.
All the businesses will be taxed on the same basis:
Somewhat lower taxes will be paid by most manufacturing, utility, finance, retail and wholesale firms, while higher taxes will be paid by service industries. The result was not unexpected, but was a planned consequence of taxing all business on the same basis.
Who is subject to the Tax?
All persons engaged in a "business activity" are subject to the Single Business Tax. All activities of a business conducted in Michigan including, but not limited to, manufacturing, contracting financing and retailing are considered business activities and subject to Single Business Tax.
"Business activity" is:
1. Sales of real or personal property for a consideration
2. Rental of property:
a. Real property - including housing, apartments, upstairs flats, etc.
b. Other property
3. Performance of a service for a fee except:
a. Services rendered as an employee
b. Services rendered as the director of a corporation
4. Any combination of the above.
"Person" means an individual, firm, bank, financial institution, limited partnership, co-partnership, partnership, joint venture, association, corporation, receiver, estate, trust, or any other group or combination acting as a unit.
Who is required to file a return?
Any "person" engaged in a business activity whose apportioned or allocated gross receipts form that activity plus capital acquisition deduction recapture equal or exceeds the filing threshold must file a tax return. An annual or final return must be filed with the Revenue Division, Department of Treasury, in the form and content prescribed, by the last day of the 4th month after the close of the taxpayer's tax year; April 30th, in the case of a calendar year end. Any final liability must be paid with the return.
Filing threshold: A person whose apportioned or allocated gross receipts plus the capital acquisition recapture are less than the following amounts need not file a return or pay tax.
1. $40,000 for tax years starting before 1-1-91
2. $60,000 for tax years starting after 12-31-90 and before 1-1-92
3. $100,000 for tax years starting after 12-31-91 and before 1-1-94
4. $137,500 for tax years starting after 12-31-93 and before 1-1-95
5. $250,000 for tax years starting after
12-31-94 and before 1-1-03
6. $350,000 for tax years starting after
If the tax year is less than 12 months, the above amounts are reduced proportionately.
Affiliated/controlled groups, entities under common control: An affiliated group of corporations, or an entity under common control must consolidate the gross receipts of the entities to determine if a person need not pay a tax or file a return. The filing threshold is based on apportioned gross receipts. Therefore, the apportioned receipts of the group would be the determinant for whether or not members of the group would have to file. Combined sales of both a Michigan and non-Michigan member would be apportioned based on a consolidated apportionment formula. Inter-company sales would be eliminated.
Extension: Upon application and for reasonable cause shown, the commissioner of revenue may extend the filing of the Form C-4737. An approved extension does not extend the payment of tax. A tentative return and payment of estimated tax will be required. When a taxpayer is granted an extension for federal purposes, filing a copy of the federal extension requests together with a tentative return and payment of estimated tax with the Commissioner by the due date set for the return automatically extends the due date for an equivalent for an equivalent period plus 60 days.
Many taxpayers who previously were not required to file a Single Business Tax return must now file as a result of the above provision in the 1994 Single Business Tax Amendments.
The legislation reduced the Single Business Tax rate from 2.35 percent to 2.3 percent and the alternate profits tax rate form 3 percent to 2 percent, effective October1, 1994. It also increased the gross receipts filing threshold from $100,000 to $137,500 for tax years beginning after December 31, 1993, and to $250,000 for tax years beginning after December 31, 1994.
The affiliated/control group change will require the preparation of a number of additional Single Business Tax returns. The provision requires gross receipts of all controlled groups, including affiliated groups, controlled groups of corporations and entities under common control, to be consolidated for purposes of determining whether or not a Single Business Tax return must be filed.
This means all entities must file a Single Business Tax return if the aggregated apportioned gross receipts (plus recapture of capital acquisition deduction) exceed the filing threshold. This change is effective for tax years ending after June 30, 1994.
A subsequent amendment would eliminate the Single Business Tax filing requirement for a person whose gross receipts did not exceed $100,000 notwithstanding the fact that they were part of a controlled group.
Receipts for the following entities must be aggregated:
1. Parent and subsidiaries
2. A bother-sister group of entities.
Such a group exists if:
1. The same five or fewer persons who are individuals, estates, or trusts own (directly and indirectly) an 80 percent or more interest in each entity, and
2. Taking into account the ownership of each person only to the extent such ownership is identical with respect to each such entity, such persons own more that 50 percent of each entity.
3. Combined group of entities under common control. Any group of the three or more entities, providing the following conditions exist:
a. Each entity is a member of either a parent-subsidiary group or a brother-sister group of entities under common control, and
b. At least one entity if the common parent entity of a parent-subsidiary group of entities under common control and is also a member of a brother-sister group of entities under common control.
The most common situation covered by the change is one or more partners in a partnership or shareholders in a corporation receiving rent from the partnership corporation either individually or through a partnership. The tax return would be required if gross receipts exceeded $100,000.
Choice of Entity
The Single Business Tax is imposed on all persons engaged in a business activity. Section 6(1) of the Single Business Tax Act states: " Person' means an individual, firm, bank, financial institution, limited partnership, co-partnership, partnership, joint venture, association, corporation, receiver, estate, trust, or any other group or combination acting as a unit. Since the enactment of the Single Business Tax, the Michigan legislature has created the Limited Liability Company. The LLC is subject to the Single Business Tax because it is ""any other group or combination acting as a unit."
A Michigan business has several options as to "choice of entity". The various options have differing tax ramifications. There are also some traps and tax planning opportunities with the "choice of entity".
Tax issues include considerations such as single versus double taxation, individual versus corporate tax rates, ease of formation, property transfers, dissolution, and flexibility of ownership structure. The following is a brief discussion of some of the federal and Single Business Tax considerations with the "choice of entity" decision. .
The business owners might prefer to organize the entity as a traditional C-corporation. To organize as a C-corporation requires the filing of articles of incorporation with the state. The "C" corporation will pay federal income taxes at the corporate level and on the shareholder level when earnings are distributed. "Double taxation" is the main disadvantage of the "C" Corporation. If the earnings were below $50,000, they would be taxed at the 15% rate.
If pass through entity status is preferred, yet the business owners still want to maintain the corporate legal form, then an election to be treated as an S-corporation can be filed. This election must be filed before the 16th day of the third month of the tax year the election is to take effect.
A corporation may elect to be an S-corporation only if it meets the requirements listed below:
1. It is a domestic corporation.
2. It has no more than 75 shareholders. A husband and wife (and their estates) are treated as one shareholder for this requirement. All other persons are treated as separate shareholders.
3. Its only shareholders are individuals, estates, exempt organizations described in Section 401(a) or 501(c)(3), or certain trusts described in section 1361(c)(2)(A) (Qualified Subchapter S Trusts)
4. It has no nonresident alien shareholders.
5. It has only one class of stock (disregarding differences in voting rights). Generally, a corporation is treated as having only one class of stock if all outstanding shares of the corporation's stock confer identical rights of distribution and liquidation proceeds.
6. It is not an ineligible corporation.
7. It has a permitted tax year as required by section 1378 or makes a section 444 election to have a tax year other than a permitted tax year.
8. Each shareholder consents to the election.
There are several operational issues unique to the "S" Corporation. The "S" Corporation will file and report income and expenses for federal income tax purposes on Form 1120S. A Federal Form K-1 will be filed with the return for each owner to report his or her share of income and expense. Each owner will report on their personal income tax return the income and expenses from the Form K-1. The entity taxed as an "S" Corporation cannot make disproportionate distributions.
Limited Liability Company
If the pass through status is preferred yet the above requirements present an obstacle, the owners may be inclined to consider the Limited Liability Company (LLC) as an alternative form of pass through entity. LLC's provide more flexibility of ownership structure and profit and loss allocations than do S-corporations.
The LLC has the option of being taxed for federal income tax purposes as either a corporation or as a partnership. An LLC electing to be taxed as a corporation can also make an "S" Corporation election. The differences in the federal taxation of LLC's taxed as partnerships and of S-corporations is very complex and will need to be addressed.
The legal formation of the LLC requires the filing of articles of organization with the state. While legally the LLC is a non corporate entity, the Internal Revenue Service has issued regulations which allow the LLC to elect to be taxed as either a partnership or as an association taxed as a corporation.
If the LLC wishes to be taxed as a corporation then the election is a proactive election. The LLC must file form 8832 Entity Classification Election within 75 days of the day on which it wishes the election to be effective. If an LLC does not proactively elect a tax classification then the default classification is as a partnership.
Michigan Single Business Tax
On November 29, 1999, the Michigan Department of Treasury (Department) provided some guidance on the Michigan treatment of federal entity classification. In Revenue Administration Bulletin 1999-9 (RAB 99-9) Effect of Federal Entity Classification Election on Michigan Taxes (Exhibit 3) the Department states that for purposes of the Small Business Credit "a member of an LLC is treated as a partner if the LLC is taxed as a partnership".
RAB 99-9 then goes on to state that for purposes of the Small Business Credit; "If an LLC or other unincorporated entity elects to be treated as a corporation, . a member is not considered a "shareholders" for purposes of the small business credit because the Single Business Tax Act specifically defines "shareholder" as an owner of stock for purposes of computing the credit." The Single Business Tax Act also specifically defines "Officer" for purposes of computing the credit as "an officer of a corporation other than an S-corporation".
This literal interpretation of "shareholder" and "officer" by the Department provides some unexpected flexibility in choosing which type of entity to form for your Michigan business. Because the member of an LLC electing to be taxed as a corporation is not a "shareholder", the Small Business Credit $95,000/$115,000 disqualifier is not applicable.
Under Federal Treasury Regulations Sec. 301.7701-3 "Check the Box" (Exhibit 4), an LLC can proactively elect to be taxed as a corporation. In RAB 99-9, the Department of Treasury states that "Michigan conforms to federal check-the-box regulations (Treasury Regs Sec. 301.7701-1 through 301.7701-3) for SBT purposes." Therefore a Michigan LLC can elect to be taxed as a corporation.
Subchapter S of the Internal Revenue Code allows a corporation to elect to be taxed as an S-corporation if it meets certain requirements. We have listed those requirements above. Under this scenario, a Michigan LLC could elect to be taxed as a corporation and concurrently elect to be taxed as a Subchapter S-corporation. In this case, the compensation of the members of the LLC will not be taken into consideration in computing the requirements for the Small Business Credit. Under this scenario the members of the Michigan LLC taxed as an S-corporation could be paid any compensation level by the LLC without placing the LLC's use of the Small Business Credit in jeopardy.