SINGLE BUSINESS TAX AMENDMENTS

House Bill 5098 (Substitute H-2)

Sponsor:  Rep. Paul Condino

Committee:  Tax Policy

Complete to 8-31-05

A SUMMARY OF HOUSE BILL 5098 (H-2)AS REPORTED FROM COMMITTEE

The substitute bill would make a variety of amendments to the Single Business Tax Act to do the following: 

·                    Add to "business income" the amount of the federal domestic production activities deduction.

·                    Treat members of a limited liability company (LLC) like officers, shareholders, partners, and individuals for purposes of the small business credit, for tax years that begin on or after January 1, 2007.

·                    Include all members of a group of companies with common ownership in determining whether a controlled group is small enough to take the small business credit.

·                    Eliminate the apprenticeship credit as of December 31, 2005.

·                    Prevent firms with an unused SBT loss or credit obtained while filing separately from using up that loss or credit faster by filing a joint return with an affiliate in a later year. 

·                    Specify that underpayment due to some of the changes proposed in the bill with respect to the small business credit would not subject the taxpayer to penalties imposed under the act. 

            The bill is tie-barred to House Bills 4980, 5095-5097, and 5106-5108.

           

Business Income and the Federal Domestic Production Activities Deduction

The starting point in calculating a firm's single business tax liability is the firm's "business income," which the SBT Act defines to mean federal taxable income or, for a firm other than a corporation, that part of federal taxable income derived from a business activity.[1]  The bill would add that "business income" also includes the amount of a deduction claimed under Section 199 of the Internal Revenue Code related to domestic production activities. This provision was also included in the governor's proposed Michigan Jobs and Investment Act (House Bill 4476). 

The Domestic Production Activities Deduction, effective for tax years beginning after December 31, 2004, was recently added to the Internal Revenue Code with the enactment of the American Jobs Creation Act of 2004 (P.L. 108-357).  Ostensibly the deduction was created to offset the repeal of the extraterritorial income exclusion (EIE) that was necessary to bring the U.S. into compliance with a World Trade Organization ruling that found the EIE to be an illegal export subsidy.  When fully phased in, the deduction is equal to nine percent of the taxpayer's "qualified production activities income" or taxable income, whichever is less, and limited to half of wages paid in the calendar year.[2]

According to a June 2005 survey by the Foundation of Tax Administrators, the District of Columbia and 13 states have made a determination to not conform with the deduction, while five others were considered likely to not conform.  Those 13 states identified by the FTA that do not conform to the deduction include: Arkansas, Georgia, Hawaii, Indiana, Maine, Maryland, Massachusetts, Mississippi, North Dakota, North Carolina, Tennessee, Texas, and West Virginia.  The FTA's survey identified California, Minnesota, New Hampshire, New Jersey, and South Carolina as being likely to not conform to the deduction.  Of those, legislation passed in Minnesota, New Jersey, and South Carolina since the survey results were released, and legislation is still pending in California.   

           

Small Business Credit

Under the act, certain small, low-profit businesses may calculate their SBT liability by either claiming the small business credit or calculating their tax liability using the alternative tax rate.  The bill provides that, for taxes that begin on or after January 1, 2007, limited liability companies would be subject to the same compensation limits as other businesses and that affiliates of out-of-state companies are subject to the same combined gross receipts limits as affiliates of in-state companies when utilizing the credit or alternative tax rate. 

The small business credit was first established with the enactment of Public Act 273 of 1977, and is available to firms meeting the following criteria: (1) gross receipts not exceeding $10 million, (2) adjusted business income not exceeding $475,000, (3) and individual shareholder or officer-allocated income not exceeding $115,000.  The credit is based on the ratio of adjusted business income to 45 percent of the SBT base.  After application of the credit, a firm's tax liability is equal to the product of (1) the tax liability before the credit, and (2) the quotient of adjusted business income and 45 percent of the tax base. 

Public Act 390 of 1988 established the alternative tax for small business.  A firm's tax liability under this method is equal to two percent of adjusted business income.  The alternative tax rate was initially set at four percent, and decreased to three percent for the 1992 and 1993 tax years, and lowered to the current rate for tax years beginning October 1, 1994.  It should be noted that while the current alternative tax rate is slightly higher than the current standard rate of 1.9 percent, the alternative tax is levied on a much narrower tax base. 

This provision would also be added under the proposed Michigan Jobs and Investment Act (HB 4476), and was previously part of the "loophole-closing" package of legislation from last session that accompanied Governor Granholm's FY 2004 Executive Budget Recommendation.  The Department of Treasury contends that members of a limited liability company are not treated in the same manner as officers, shareholders, partners, and individuals for the purpose of the small business credit because the law has not been updated to include this relatively new business form.  LLC's that currently compensate members in excess of the limits to continue to receive the credit; the bill would instead treat LLCs like other firms. 

The department further notes that members of a group of companies with common ownership are required to combine their activities for the purposes of the small business credit, although, due to a 1987 state court of appeals decision[3] only those companies that are physically located or taxable in Michigan are included in determining eligibility for the credit.  As such, a business can be disqualified from the credit if it is owned by a Michigan business, but be eligible for the credit if it is owned by a similar business without ties to Michigan. 

According to the Department of Treasury, the bill would make eligibility standards for the small business credit apply uniformly to all types of business organizations and eliminates favorable treatment for small business with an out-of-state affiliate.

Apprentice Credit

Under the act, a taxpayer may claim a refundable credit for each apprentice and "special apprentice" trained by the taxpayer in the tax year. The credit is equal to the sum of the following: (1) one-half of salary, wages, fringe benefits, and other payroll expenses paid to or for the benefit of the apprentice; and (2) the costs of classroom instruction and related expenses for which the taxpayer is responsible under an apprenticeship agreement.  The credit is capped at $2,000 (or $4,000 for tool and die companies) for each apprentice and $1,000 for each special apprentice.  The bill would only allow expenses incurred before January 1, 2006 to be used to calculate the credit. 

The act defines "apprentice" to mean a state resident who is between 16 and 19 years of age and has not obtained a high school diploma, but is enrolled in a GED program, and is trained in an approved apprenticeship program.  A "special apprentice" is defined to mean a state resident who between 16 and 24 years of age and is trained in an approved apprenticeship program. 

Credit & Loss Carryforward

Under the act, a firm can "carry forward" certain credits and losses to offset tax liability into a specified number of years in the future if they exceed the firm's tax liability in the years in which they are first claimed.  For example, the act permits a firm to claim a credit for expenditures to rehabilitate a historic resource, and further provides that the amount of the credit and any unused carryforward that exceeds the firm's tax liability for the tax year can be carried forward to offset tax liability for ten years or until used up, whichever occurs first. 

The bill would amend the act to specify that a business that filed a consolidated or combined return could not claim a credit carryforward or loss carryforward in an amount greater than the amount that could have been claimed if the member (i.e. a subsidiary) from whom the carryforward originated was filing a separate return, if the carryforward was from a year in which the member did not file a return on a consolidated or combined basis. 

In the 2003-04 session, this provision would have been added by House Bill 4570, introduced by then-Representative William J. O'Neil, and was part of the "loophole-closing" package of legislation that accompanied Governor Granholm's FY 2004 Executive Budget Recommendation.  At the time, the Department of Treasury contended that this provision served to prevent a firm with an unused SBT loss or credit obtained while filing separately from using up that loss or credit faster by filing a joint return with an affiliate in a later year. 

Penalties

The bill would specify that interest and penalties imposed under the act would not be assessed against a taxpayer in the tax year during which the changes made by the bill become effective if an underpayment is due to the changes made by the bill regarding the credit and loss carryforward for disregarded entities, "business income" and the federal domestic production activities deduction, or the small business credit. 

FISCAL IMPACT:

House Bill 5098 (H-2) would increase SBT revenue, all of which accrues to the GF/GP, by an estimated $11.8 million on a full year basis.

                                                                                           Legislative Analyst:   Mark Wolf

                                                                                                  Fiscal Analyst:   Rebecca Ross

■ This analysis was prepared by nonpartisan House staff for use by House members in their deliberations, and does not constitute an official statement of legislative intent.

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