Deductible or not deductible? The Michigan SBT question.

• Author: Curlee, William B.
• Position: Single Business Tax

The majority of states that impose a corporate income tax begin the computation of state taxable income with the corporation's taxable income as reported on either line 28 (taxable income before net operating loss and special deductions) or line 30 (taxable income) of Form 1120, U.S. Corporation Income Tax Return. The selected Federal figure is then adjusted for various state-defined additions and subtractions to determine the corporation's state taxable income.

In determining the corporate tax base, most states require a corporation to add back state income taxes previously deducted in arriving at Federal taxable income. Some states require that only their income taxes be added back to Federal taxable income in computing state taxable income, while other states include all state income taxes. Several states require that all state, local, foreign and Federal income taxes deducted in computing Federal taxable income be added back. The distinction between a direct income tax and a franchise tax measured by income may be significant in this connection; however, most states include both kinds of taxes in the statutory definition of a nondeductible tax.

In determining deductibility, the most controversial of all of the state taxes is the Michigan Single Business Tax (MSBT). Numerous court cases, including the Supreme Court's decision in Trinova v. Michigan Department of Treasury, have described the MSBT as a value-added tax, rather than a tax based on income. The MSBT is levied on the privilege of doing business in Michigan. While Federal taxable income is the starting point for the MSBT, there are significant modifications that must be made in determining the tax base. Adjustments are made for such items as employee compensation, depreciation, taxes, net operating losses, and partnership income or loss. Additional modifications are made for Michigan's capital acquisition deduction and statutory exemptions. Finally, a significant deduction is allowed that limits the tax base to no more than 50% of adjusted gross receipts.

The deductibility of the MSBT varies significantly among the states. While some states permit a deduction for the entire MSBT, others do not allow a deduction for any portion of it. As a middle ground, a few states attempt to bifurcate the tax into a deductible and a nondeductible component. Several states have recently modified their positions on the deductibility of the MSBT. If a state has not specifically addressed the...