Don’t Expect an Elton John Tribute Song to the Death of the MBT

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This is the last year for the Michigan Business Tax.  On January 1, 2012 Michigan C corporations will be subject to a 6% income tax.  Flow through entities such as S corporations, LLCs, and partnerships will no longer be subject to a business level tax.  The owners of flow through entities will pay tax on their business income on their personal returns, as they currently do. 

Michigan will therefore treat flow through entities as they are treated at the federal level.  At the federal level, C corporations pay income tax on their profits at the business level.  When the C corporation pays a dividend, buys back stock from its shareholders, or the shareholders sell their stock to a third party, the shareholders pay income tax at the personal level.  This is double taxation.

For flow through entities, the business does not pay a business level tax.  Instead, the profit flows through to the owner.  The owner pays tax on the annual business profit (whether or not distributed).  The owner will then be able to withdraw the profit from the business without paying tax.  Thus, there is only a single layer of tax.

Under the MBT, business owners of flow through entities were subjected to double taxation.  First, the business would pay MBT at the business level.  Then, business owners would pay tax on the business profit on their personal returns.  Double taxation for flow through entities under the MBT was even harsher than double taxation for C corporations at the federal level because, at the federal level, C corporation shareholders would not be subject to double taxation until they received cash through a dividend, share buyback, or sale of their stock.  Under the MBT, business owners paid two levels of taxation even if they did not take cash out of the business. 

Example: C corporation has profit of $200,000.  It pays corporate level tax of $61,000.  Let’s assume it pays $12,000 in MBT.  The shareholders do not pay a personal level tax under either federal law or MBT if they did not receive dividends or sell their stock to the corporation or to a third party.

Now assume the above corporation was an S corporation.  At the federal level, the shareholder pays personal income tax on the $200,000 of profit.  Assuming a 30% income tax rate, the shareholder pays tax of $60,000.  There is no business level federal tax.  At the state level, the S corporation still pays the $12,000 MBT, AND the shareholder pays personal income tax of $60,000 on the S corporation profit of $200,000.  The flow through business owner is subject to double tax even if the shareholder took no money out of the business.

Under the Corporate Income Tax (CIT), the business would not be subject to tax at the business level.  The shareholders would continue to be taxed on their personal returns.  The shareholders in this example saved $12,000 they previously paid in MBT.

The new CIT of 6% that applies only to C corporations will be very, very helpful to flow through entities. 

To say that CIT is much simpler than the MBT would be an understatement.  Here are some characteristics of the CIT:

  • C corporations with gross receipts under $350,000 are exempt from CIT
  • There is a small business credit for small business that effectively reduces the 6% tax rate to a 1.8% tax rate
    • To qualify, a business must have gross receipts of $20 million or less and have adjusted business income of $1.3 million or less
    • Adjusted business income is basically business profit plus shareholder/officer compensation
    • this credit existed under both the SBT and MBT and is retained for the CIT
  • Taxpayers who have certain credits can continue to file MBT returns to continue claiming these credits.

More to come on the new Michigan tax laws.  Stay tuned.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

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