DEDUCTIBLE OR NOT DEDUCTIBLE? THE MICHIGAN SBT QUESTION.

• Author: Boucher, Karen J.

Editor's note: Ms. Boucher chairs the AICPA Tax Division's State & Local Taxation Technical Resources Panel.

If you would like additional informaion about this article, contact Ms. Boucher at karen.j.boucher@us.arthuranderson.com.

The majority of states that impose a corporate income tax begin the computation of state taxable income with a corporation's taxable income, as reported on either line 28 (taxable income before net operating loss (NOL) 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 addition and subtraction modifications 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 own income taxes be added back to Federal taxable income in computing state taxable income, while other states require that all state income taxes be added back. Several states require 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; in general, however, most states include both kinds of taxes in the statutory, state tax add-back.

In determining deductibility, the most controversial of all of the state taxes is the Michigan single business tax (MSBT). Numerous court cases, including the U.S. Supreme Court's decision in Trinova Corp. v. Michigan Dep't of Treasury, 498 US 358 (1991), have described or defined the MSBT as a value-added tax (VAT), 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, NOLs and partnership income or loss; additional modifications are made for statutory exemptions and, in tax years beginning before 2000, Michigan's capital acquisition deduction. 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 states. While some states permit a deduction for the entire MSBT, other states do not allow a deduction for any portion of it. As a middle road to those approaches, a few states attempt to bifurcate the tax into deductible and...