Michigan Business Lawyer Blog

The new Michigan Business Tax was enacted with the supposed aim to benefit Michigan businesses by replacing the much hated Michigan Single Business Tax with a tax that was fair, reasonable, and economically viable. But as it turns out, it may be that the cure is worse than the disease.

Crain's Detroit Business magazine has a recently posted story that demonstrates some of the unintended consequences that the new tax act seems to be having. This article highlights the state tax travails of a Plymouth, Michigan high tech company named Stardock Corporation. Crain's notes that Stardock is exactly the kind of company that Michigan should be working to cultivate. It's a high technology and entertainment enterprise that creates computer games and software. It has 55 employees and projects gross revenue this year of approximately $18 million.

Stardock's tax troubles are very simple: Under the old Michigan single business tax, it's state business tax liability was approximately $1,200. Under the new Michigan Business Tax and its accompanying surcharge, it's state business tax liability this year will be almost $170,000! Not surprisingly, the company is contemplating a move to a more tax friendly state. Stardock claims that it wants to pay its fair share of taxes but that its tax burden under the new Michigan Business Tax and surcharge are so "lopsided" that it would be "suicide" to stay in Michigan unless there is some sort of favorable resolution.

This article is good food for thought. In addition to Stardock, many other Michigan businesses are facing steep tax increases under the new Michigan Business Tax. Of course, companies should have to pay their fair share of taxes. But, it seems that the current Michigan business tax structure has gone beyond that goal and is actually causing businesses that Michigan sorely needs to consider leaving the Great Lakes State. That's not good for anyone in Michigan.

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Posted In: Michigan Business News , Tax Issues

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Generally, if you purchase equipment for your business you have to depreciate the cost of that equipment little by little over multiple years. However, for certain equipment purchases, IRS Code Section 179 provides a way for businesses to deduct the entire cost of an equipment purchase in one year instead of over a number of years.

Quite simply, Section 179 allows businesses to simply expense certain equipment purchases instead of depreciating them. In practical terms, a Section 179 deduction means that a business gets to claim all of the money paid for the purchased equipment in the year the equipment is purchased. If the equipment purchase was depreciated, that benefit would have to be spread out over a number of years.

There are a number of requirements for a business to use Section 179:

1. A business needs to have taxable income of at least the amount that it will expense under Section 179. This taxable income can come from a variety of sources.

2. A business can either expense items under Section 179 or depreciate those items over multiple years, but not both.

3. Any item that is expensed under Section 179 must be used for more than 50% for business purposes. If it is used less than 100% for business, only the percentage used for business purposes can be claimed.

4. Any equipment that is expensed under Section 179 should still be used 50% or more for business purposes for the same number of years that it would have otherwise been depreciated.

There are a number of items that Section 179 does not apply to such as real estate, inventory items, property purchased from a relative, heating and air conditioning units, and items already owned in a previous year that are being converted to a business use.

If you own a Michigan business and have any questions about taking a Section 179 deduction, you should contact an accountant or a Michigan business lawyer for more information.

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Posted In: Tax Issues

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Although no one starts up a business with plans to fail or lose money, the success rate statistics for new businesses can be daunting. That's why Section 1244 stock should be on the mind of every new business owner who organizes their business as a C corporation.

Section 1244 stock is possible thanks to Section 1244 of the Internal Revenue Code. This is known as the small business stock provision, and was enacted to allow stockholders of domestic small business corporations to deduct losses incurred when they dispose of their small business stock as ordinary losses instead of capital losses.

The general rule is that any loss suffered by a stockholder upon liquidation of the company will be considered a capital loss. But, if the stock is Section 1244 stock, a part of the loss ($100,000 for husband and wife filing jointly, otherwise $50,000) will be treated as an ordinary loss. Since the loss is treated as ordinary, it can be used directly to offset the stockholder's investment income, passive income, wages, and self-employment income. In addition, because the use of the loss is accelerated, the tax advantage is much greater than if the loss is treated as capital.

Whether stock is Section 1244 stock depends on whether the requirements of IRC 1244 are met at the time the stock is originally issued. These requirements relate to (1) the corporation issuing the stock; (2) the stock itself; and (3) the stockholders of the corporation.

Being able to issue Section 1244 stock is one of the great tax benefits of organizing a business as a C corporation. Of course, you should consult with a knowledgeable Michigan business lawyer when setting up your corporation so that he or she can advise you on the requirements for issuing valid Section 1244 stock.

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Posted In: Business Formations , Corporations , Financing , General Topics , Tax Issues

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One advantage Michigan C corporations have over S corporations is the ability to reinvest profits in the corporation at a lower tax cost than S corporations. This is because the current lowest corporate income tax bracket is 15% for profits up to $50,000. The individual income tax bracket of a company's owner is often higher than 15%. So if that owner wanted to reinvest S corporation profits back into the S corporation, he or she could do so only after paying personal income tax on those profits at their personal income tax rate (because of the "flow through" tax treatment of S corporations). Since a C corporation is not a "flow through" tax entity, any profits not distributed to the shareholders (such as those reinvested back into the corporation) are taxed at the corporate level only.

So, let's say a start-up corporation decides to operate as a C corporation to take advantage of the lower tax cost of reinvesting profits back into the company. At some point, the company may exhaust its desire for reinvesting its profits, and decide that it wants to start distributing its profits to its shareholders. At this point, double taxation becomes an issue because in a C corporation, profits will first be taxed at the corporation level when they are booked, then again at the shareholder level when they are distributed to the shareholders.

The answer may be to convert the C corporation to an S corporation so that profits will only be taxed one time. The mechanics of switching from a C corporation to an S corporation are simple enough. Becoming an S corporation is simply a tax election that is made by filing the appropriate paperwork with the IRS. A corporation's shareholders can make this election any time during the corporation's existence. If the shareholders elect S corporation status, all future earnings will be taxed at their individual income tax rates, without being taxed at the corporate level.

But, corporations contemplating this move must be very careful. This is because any of the corporation's earnings before the S election will forever be marked and given special tax treatment under rules governing S corporations. If those earnings are ever distributed to the corporation's shareholders, they will be taxed as dividends and, even worse, will be subject to the double tax regime imposed on C corporations.

Corporations or stockholders who are contemplating changing their C corporation to an S corporation should consult with a Michigan business lawyer who can help them work through the possible tax pitfalls of making this move.

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Posted In: Business Formations , Corporations , Entity Selection , Tax Issues

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One fairly common technique for owners of closely held businesses to extract additional tax-advantaged income from their companies has been for them lease real estate or personal property to their businesses. This kind of rental permits the owners to withdraw money from the business without it being classified as salary or dividends. However, if closely held business owners use the rental income to offset real estate passive activity losses, they could expose themselves to possible disallowance under the IRS's self-rental rule.

In the Beacher case, the Ninth Circuit Court of Appeals (based in California) recently ruled that a closely held business owner renting real estate to their business won't result in a tax break. The court ruled that the rental income cannot be offset by passive losses even if those losses come from real estate activities. The court affirmed IRS rules that deny passive losses against rental income when the taxpayer works more than 500 hours in one year for the business, and greater than 50% of the business's stock is held by five or fewer stockholders. Although this rule applies to C corporations there is a similarly restrictive rule for rentals to S corporations.

Business owners can still obtain some tax benefit from renting to their businesses. Payroll taxes are not owed on these kinds of rental payments, unlike salary payments. But, if the rental amount is deemed not to be arm's length (i.e., it is excessive), the IRS could try to reclassify that excess amount as additional salary or possibly even as a nondeductible dividend.

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Many Michigan businesses use contracts to stipulate with certain workers that they are independent contractors and not employees of those businesses. But, businesses using contracts in this way need to be very careful. Contracts classifying workers as independent contractors instead of employees have no tax effect. The IRS can still reclassify those workers as employees if the business has enough control over them.

In Peno Trucking (TC Memo. 2007-66), the Tax Court addressed the case of a trucking company who used contracts to say certain workers were independent contractors and not employees. Peno Trucking's truck drivers had no investment in the trucks and were directed where to drive. Also, the trucking company paid all the costs of operating the trucks. The Tax Court determined that the drivers were actually employees -- despite their contracts to the contrary -- because the company controlled their work.

Businesses who have issues related to worker classification should consult with a knowledgeable business attorney to ensure they get it right and avoid any nasty IRS surprises.

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Posted In: Contracts , Employment Law , Tax Issues

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The IRS has extended fast-track mediation of tax controversies to include small business and self-employed taxpayers. The IRS touts its fast-track mediation program as its attempt to meet taxpayer needs by resolving controversy at the earliest resolution point within the IRS. The Large and Mid-Sized Business Fast-Track Settlement program was started in 2002 and is considered a success by the IRS. As a result, the IRS decided to extend the opportunity to mediate tax controversies to smaller taxpayers.

The program has been implemented on a two year trial basis. The initial six-month focus period ran from September 5, 2006, through March 5, 2007. Qualifying small business and self-employed taxpayers in the cities of Chicago, Houston, and St. Paul, Minn., were eligible to participate in the program. The program will be expanded to other cities during the trial period on a staggered roll out basis.

There are a number of benefits to the program. These include a significantly reduced IRS process as well as an assurance that the taxpayer will not be charged “hot” interest under IRS section 6621. If the taxpayer and the IRS are able to reach a resolution, the taxpayer and the IRS must both sign a consent form acknowledging acceptance of the mediated result. Taxpayers do not give up any of their rights by participating in this program and have the right to withdraw from the mediation program at any time. If there are issues that are not resolved through mediation, the taxpayer can engage the normal IRS appeal process to seek a resolution.

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The Michigan Department of Treasury has launched a new Web tool that provides a calculation of a business's future tax liability under the new Michigan Business Tax. The calculator is aimed at businesses and tax professionals, and provides unofficial estimates that are not legally binding on a business's actual liability under the new Michigan Business Tax. The new Web tool is located on the Michigan Department of Treasury’s Web site that is dedicated to providing information about the Michigan business tax.

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A number of Michigan's biggest companies are asking the legislature to raise one business tax and kill another. While everyone seems to agree that Michigan's new 6% service tax is a bad idea, the alternate plan being pushed by Michigan big business would shift the major portion of the business tax burden to thousands of smaller businesses. The big businesses supporting the new plan include the Big Three automakers, and big insurance and banking companies.

The Michigan House of Representatives has obliged these big companies, by passing legislation that would replace the unpopular service tax with a 32.9% surcharge on the new Michigan Business Tax. It is unclear at the present how the Michigan Senate will deal with this legislation. The Michigan Business Tax is scheduled to replace the Single Business Tax on January 1, 2008. The Michigan Business Tax gives gives increased tax breaks to manufacturers and other enterprises that invest in facilities located in Michigan and hire Michigan employees.

The 32.9% surcharge would be imposed on sales and income and would be applied before tax credits. The reason why big business is behind the surcharge plan is that there is a cap on the surcharge so that no single business would pay more than $2 million per year. $2 million per year is a fraction of what the Big Three would pay under the service tax. This is because these companies use so many different kind of services that will be included in the new service tax such as landscaping, consulting, warehousing, and janitorial.

The 6% service tax was a hastily put together solution reached on October 1, 2007 in order to keep the Michigan government from shutting down due to a budget shortfall. The service tax has received very bad reviews from businesses big and small. The surcharge proposed under the Michigan Business Tax would replace all revenue that the service tax is estimated to raise, which is $614 million this fiscal year and $750 million the next.

Michigan's business tax situation is far from settled, with a variety of plans being proposed from a number of different corners. Depending on the exact proposal, it can be difficult to map out which companies will lose and which will win in the final analysis. However, one thing is sure, all of this uncertainty cannot be good for attracting new companies and businesses to Michigan.

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Posted In: Michigan Business News , Tax Issues

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The Michigan Department of Treasury has created a new Web site that is focused on recent state tax changes, including information on Michigan's new 6 percent tax on services.

The new website provides pages for specific tax changes, including the service tax, the Michigan Business Tax and the new income-tax rate. Information on the new service tax includes descriptions of services either subject to or exempt from tax, as well as filing dates, forms, and frequently asked questions.

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On Thursday, July 12, 2007 Michigan Gov. Jennifer Granholm signed into law a replacement for the controversial Single Business Tax that its supporters said would jump start the languishing Michigan economy. The Single Business Tax had long been hated by businesses in Michigan, and was seen by many as one of the factors that discouraged more businesses from investing in Michigan. Gov. Granholm has stated that she believes the new tax will give everyone in Michigan the opportunity to promote the state as "open for business."

Continue reading "Michigan Governor Signs New Michigan Business Tax Bill into Law" »

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Michigan Business News , Tax Issues

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