THE TAX ATTIC with Jerry Coon

Jerry Coon

A closer look at business tax changes

Last week, I discussed the Michigan individual tax changes that will take effect on January 1, 2012. The blunt fact is that individual taxes will increase for many Michigan taxpayers.

This week, I will discuss the reason for many of those changes. That reason predominantly is explained by looking at the changes in how businesses will be taxed as of January 1, 2012.

The blunt fact is that taxes will decrease for many Michigan businesses. By reducing the taxes on businesses, total revenues are decreased.

The State of Michigan requires a certain amount of money to operate. If that money isn’t coming from businesses, it comes from individuals. It’s not rocket science.

The decision was made by the legislators to lower the gross amount of taxes paid by businesses. Once that decision was made, increased taxes on individuals in some format had to occur. Those individual changes were the changes we discussed last week and they effectively shifted approximately one billion dollars of tax from businesses to individuals.

On December 31, 2011, the old way of taxing businesses, called the Michigan Business Tax (MBT), becomes extinct. From a professional income tax preparer point of view, good riddance to the MBT. It was a difficult return to prepare and full of exceptions to the rules. I like to call those exceptions “gotchas.” If you make a mistake on one of those exceptions, the Michigan Department of Treasury sends out one of those “gotcha” letters and the recipient ends up paying more tax. Most tax professionals are not unhappy to see the MBT eliminated.

Let’s look more closely at those business tax changes. Most importantly, only businesses that file the federal Form 1120 will be subject to the Corporate Income Tax (CIT). Currently, entities with gross receipts of at least $350,000 are subject to MBT tax. This includes corporations filing Form 1120, Subchapter S corporations filing Form 1120S, partnerships filing Form 1065, and LLCs and individuals filing a Schedule C or Schedule E.

The MBT was a tax on business activity regardless of the entity generating the business activity as long as the activity generated at least $350,000 of gross receipts. That’s an important item to note. It was a tax on business activity and not necessarily a tax on business profits. A business could have a business loss and still end up having to pay MBT tax. Ultimately, it was viewed as a negative incentive to operating a business in Michigan.

Under the CIT, only corporate Form 1120 filers will be subject to the CIT at the rate of 6%. It is now a corporate business tax and not a business activity tax.

There is a misunderstanding among many of us when we say that businesses are going to save tax dollars when we switch to the CIT. The implication is these businesses are all of the General Motors type. That simply is not true. Many of the businesses that will save tax dollars are the 1120S Sub S Corporations, the 1065 Partnerships and the Sole Proprietors or LLCs of Michigan.

Remember that most businesses with gross receipts in excess of $350,000 were subject to the MBT. Now 1120S, 1065, and Schedule E and Schedule C filers will not be subject to this business tax. These are called flow-through entities because the profits generated from these entities flows through to the individual. The profits are already taxed to the individual owner at the individual tax rates.

The MBT was an added tax—a surcharge of sorts. If the individual tax rate is 4.35% and the MBT tax rate is 2.35%, then these flow-through entities really paid tax on profits at the total rate of 6.70%. Now these flow-through entities will only pay tax at the rate of 4.35%. Businesses filing a Form 1120 where the income does not flow through to any individual taxpayers will pay tax at the 6% rate.

Actually, that sounds quite fair to me. What is debatable is how the tax revenue shortfall was made up.

Only time will tell if the changes made to the individual tax system will completely off-set the changes made to the business tax system. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns Action Tax Service in Rockford.
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