United States: Michigan Treasury Issues Notice on MBT Treatment of Federally Disregarded Business Entities

The Michigan Department of Treasury has issued long-awaited guidance in the form of a Notice addressing how taxpayers should treat federally disregarded business entities for purposes of the Michigan Business Tax (MBT).¹ The Notice requires taxpayers with federally disregarded entities to treat these entities as separate filers under the MBT, consistent with the Treasury's posture on prior Single Business Tax (SBT) filings. However, the new policy in the Notice contrasts with current MBT form instructions, and taxpayers affected by the change in policy will be required to file and amend MBT returns for current and prior tax years.

Background

Historically, a taxpayer that was disregarded for federal income tax purposes was considered to be treated in the same manner for purposes of the SBT.² However, on May 12, 2009, the Michigan Court of Appeals held in Kmart Michigan Property Services LLC v Dep't of Treasury,³ that a federally disregarded single-member limited liability company (SMLLC) was nevertheless required to file an SBT return separate from its owner.⁴ This decision was contrary to the Treasury's position taken in Revenue Administrative Bulletin (RAB) 1999-9⁵ that a taxpayer was restricted to the same entity filing status for SBT purposes that it had used for federal tax purposes for the same tax period. The Michigan Supreme Court declined to hear the case⁶ and the Treasury accepted the decision as final.

Following the decision in Kmart, the Treasury released a Notice⁷ concluding that Kmart would be applied to all open tax years, invalidating the portions of RAB 1999-9 and RAB 2000-5⁸ to the extent such RABs were inconsistent with Kmart. Under this Notice, the Treasury allowed taxpayers that would benefit from the application of the Kmart case to file for refund claims, but limited this benefit to all open tax years instead of all tax years beginning on or after January 1, 1997, the date on which RAB 1999-9 was originally effective. In contrast, taxpayers owing taxes as a result of the application of the Kmart case were required to file SBT returns back to tax years beginning on or after January 1, 1997.

In response to the Notice issued in the aftermath of the Kmart decision, Michigan enacted what it termed to be "curative" legislation earlier this year.⁹ The legislation prevents the Department from: (i) assessing a taxpayer an additional tax or reducing an overpayment because the taxpayer originally included a disregarded entity on its SBT return; and (ii) requiring the disregarded entity to file a separate return. In addition, the legislation bars a taxpayer that filed an SBT return which included an entity disregarded for federal income tax purposes from claiming a refund based on the disregarded entity filing a separate return as a distinct taxpayer.¹⁰ As a result of the legislation, the Treasury rescinded its Notice discussing the effect of Kmart on the SBT.¹¹

Treasury's New Policy as Stated in the Notice

Pursuant to the newly adopted Notice, and consistent with the Treasury's rationale in its previous Notice addressing the SBT, the Treasury will require a federally disregarded entity, including an SMLLC or a QSub, to either file a separate return under the MBT, or file as a member of a unitary business group to the extent the disregarded entity is part of a unitary group. The requirement applies to all open MBT periods, and a federally disregarded entity that does not file in the manner required by the Notice will be considered a non-filer for purposes of the MBT statute of limitations. Accordingly, a federally disregarded entity will be required to file amended returns for all open MBT periods to comport with this requirement, even if such amended filings do not result in a change in MBT liability. With this Notice, the Treasury effectively invalidated all guidance that previously stated that a federally disregarded entity had to file in the same manner for MBT purposes.

Imposition of Penalties and Interest

The Treasury has set a June 30, 2011 deadline for an affected taxpayer to file or amend returns pursuant to the Notice. Failure to file penalties will be assessed against any disregarded entities that do not file the required returns by the deadline. Interest from the original tax return due date is payable on any tax deficiencies resulting from the change in policy outlined in the Notice. In contrast, interest on refunds that may be owed by the Treasury resulting from the change in policy outlined in the Notice is calculated and added to the refund beginning 45 days after the refund claim is filed.

Filing Thresholds and Other Logistical Filing Issues

In the Notice, the Treasury explains that persons engaged in business activity in Michigan that have apportioned or allocated gross receipts of at least $350,000 generally are required to file an annual MBT return. Since a previously disregarded entity for purposes of the MBT will be considered by the Treasury to be a United States person subject to filing, the previously disregarded entity must determine whether it is also a member of a group of entities under common control with its parent, and if so, whether the group's total apportioned or allocated gross receipts are $350,000 or more. If the threshold amount is reached, the group is required to file an MBT return, even though a previously disregarded entity within the group may have less than $350,000 in apportioned or allocated gross receipts by itself.

In addition, the Treasury addresses several logistical issues which are likely to arise. A previously disregarded entity that does not have a Federal Employer Identification Number (FEIN) or Michigan Treasury Assigned Number (TR) must register with the Treasury before filing an MBT return, and must identify its organization type before its MBT return will be processed.¹²

A previously disregarded entity that exceeds the filing threshold or is otherwise required to file must file all required forms and supporting schedules. A previously disregarded entity, as well as any entity amending returns to remove a previously disregarded entity, must attach to each return a corresponding pro forma federal return. All MBT returns required to be filed as a result of the Notice are to be sent to the following address:

Michigan Department of Treasury

P.O. Box 30113 (with payment), or P.O. Box 30783 (without payment)

Lansing, MI 48909

Commentary

The Treasury's issuance of its latest Notice contrasts with 2008 and 2009 MBT return instructions, and is likely to result in a substantially increased compliance burden for Michigan taxpayers that own SMLLCs and other federally disregarded entities, regardless of whether total MBT liability will change. It should be noted that many taxpayers do not keep separate ledgers, or keep adequate separate ledgers, for their disregarded entities. So Michigan's position is likely to create an accounting headache as well. To the extent MBT liability will increase, affected taxpayers will need to account for such exposure in their ASC 740 (formerly FIN 48) reserves. The requirement that taxpayers pay interest on additional MBT liabilities that have suddenly appeared as a result in a change in the Treasury's policy is particularly controversial, and could be subject to challenge.

It will be interesting to see whether the Michigan legislature again decides to alter the guidance contained in the Treasury's newly issued Notice through "curative" legislation, as it did earlier this year when the Treasury addressed the SBT impact from the Kmart decision in its earlier Notice. This type of reform may be in line with the policies endorsed by Governor-elect Bill Snyder, who issued a position paper on his campaign Web site earlier this year supporting the elimination of the MBT altogether, and replacing it with a flat corporate income tax.

Footnotes

1 "Notice to Taxpayers Regarding Federally Disregarded Entities and the Michigan Business Tax," Michigan Department of Treasury, Nov. 29, 2010.

2 The SBT was repealed effective December 31, 2007, and replaced by the MBT.

3 770 N.W.2d 915 (Mich. App. 2009).

4 See former MICH. COMP. LAWS §§ 208.6 and 208.31.

5 Revenue Administrative Bulletin 1999-9, Michigan Department of Treasury, Nov. 29, 1999. This RAB was effective January 1, 1997 and covered the effect of a federal entity classification election on Michigan taxes.

6 Leave to appeal denied, 772 N.W.2d 421 (Mich. 2009).

7 "Notice to Taxpayers Regarding Kmart Michigan Property Services LLC v. Dep't. of Treasury, the Single Business Tax, RAB 1999-9, and RAB 2000-5," Michigan Department of Treasury, Feb. 5, 2010.

8 Revenue Administrative Bulletin 2000-5, Michigan Department of Treasury, June 19, 2000. This RAB concerned the Michigan tax treatment of the federal qualified Subchapter S subsidiary (QSub) election and was effective for SBT returns filed in tax years beginning on or after July 14, 1999.

9 Act 38 (H.B. 5937), Laws 2010, effective March 31, 2010.

10 Id.

11 "Rescinded: Notice to Taxpayers Regarding Kmart Michigan Property Services LLC v. Dep't. of Treasury, the Single Business Tax, RAB 1999-9, and RAB 2000-5," Michigan Department of Treasury, April 12, 2010.

12 A previously disregarded entity is instructed to select the organization type under which its parent filed its return.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.