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By Nathan Peck | MiBiz
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WEST MICHIGAN — When the Michigan Business Tax sunsets at the end of 2011, few people will be mourning its passing.

As the state prepares to move to a 6-percent Corporate Income Tax (CIT) January 1, tax accounting professionals say that businesses face a raft of decisions about how to limit their tax liabilities under the new structure.

The CIT applies to only C Corporations. As pass-through entities, S Corporations will be taxed at the 4.35 percent individual income tax rate.

First among the decisions companies will face is the decision by C Corps of whether or not to abandon their status and elect to switch to S Corp status. While a 1.65 percent differential in state taxes might not drive a company’s decision to switch to S Corp status, tax professionals say that federal taxes may make the election more beneficial. Federal corporate income tax rates range from 15 to 35 percent, but income is taxed a second time when income is distributed in dividends, while S Corp income tax is capped at 35 percent.

Daniel Lynn, partner at Beene Garter LLP, said this double taxation can bring the effective federal tax rate up to 45 percent.

“A differential of 1.65 percent in a state tax rate isn’t going to change anyone’s mind over their status,” Lynn said. “There are some big surprises people need to plan for — any corporation should periodically evaluate whether they should be an C Corp or S Corp. For a lot of closely held companies, it makes sense to be an S Corp.”

Some of the issues on the tax-planning horizon include whether the Bush-era tax cuts will be again extended and how the coming 3.8-percent Medicare tax, part of the Patient Protection and Healthcare and Reconciliation Acts of 2010, may be applicable both to dividends and passive income of S Corporations.

Lynn explained that taking into account current state and federal tax rates, as well as rates effective in 2013, a corporation that reinvests most of its income in the business may derive tax benefits from being taxed as a C Corporation. On the contrary, corporations that distribute some or all income could derive significant benefits from being taxed as S Corporations. The Internal Revenue Service and Michigan Treasury Department are taking a closer look at these disguised dividends, and may leave a potential trap for companies going forward as these taxing authorities look for additional sources of revenue.

There are benefits in S Corp status to business owners who may be looking to sell their businesses in the near future. An S Corporation will be more attractive to purchasers as it will gain any goodwill and amortize that over time, said Lynn.

“Owners can count on a much higher price with the sale of an S Corp rather than a sale of C Corp stock, which can give rise to double taxation,” Lynn said.

Curtis Ruppal, partner at Plante Moran PLLC leading the firm’s State & Local Tax Group, said companies considering electing to move to S Corp structure should wait until the state’s treasury department gives further guidance on how the CIT will be administered.

“It is premature for most businesses to reach final conclusions on tax entity structure based on the Michigan law changes enacted in May because there will be further amendments to the income tax act this fall,” Ruppal said. “It is a little early to make final decisions because we are expecting technical corrections and clarifications soon, which may make a difference.”

Ruppal said that companies must look at their end of year MBT payments and should consider making their payments before year’s end to ensure that owners can take advantage of credits within the MBT structure. Businesses should consider accelerating deductions, which are deductible against the Modified Gross Receipts tax, and looking at asset purchases, which the MBT provided a tax credit for investments in depreciable assets and will not be part of the CIT.

“I recommend companies watch their third and fourth quarter MBT estimates … so you don’t significantly overpay — what has been experienced in the past,” Ruppal said. “There have been delays in getting refunds for overpayments, especially larger overpayments. Companies won’t be able to carry it forward to another tax year, as the MBT sunsets.”

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TAGS:

• corporate income tax
• curtis ruppal
• daniel lynn
• michigan business tax
• west michigan