Don't Put the Cart Before the Horse (State Tax Planning vs. Business Purpose)

I published this post two years ago, but the idea still applies today; therefore, I thought I would re-post it as a reminder on how to, or how NOT to, implement state tax planning.

CASE: HMN Financial, Inc. and Affiliates v. Commissioner of Revenue, Minnesota; docket No. 7911-R; May 27, 2009 (State of Minnesota County of Ramsey Tax Court)

Summary of Case

This case involved, as the Court stated:

“a sophisticated tax avoidance plan involving a captive real estate investment trust (REIT), a holding company and the transfer of loans and loan proceeds in a circular pattern through the taxpayer’s entities.”

The taxpayer argued that it met the requirements of a foreign operating company (FOC) under Minnesota statutes; therefore, it must be afforded the favorable tax treatment the statute allows. The taxpayer argued the state has no authority to set its transactions aside as a sham because the taxpayer met the definitions of an FOC.

The state maintained that one cannot simply look to the status of a taxpayer to determine whether deductions will be allowed or disallowed; one must look at the transactions to determine whether deductions will be allowed.

The state argued, and the Tax Court agreed, the only true purpose of the taxpayer’s transactions was to avoid Minnesota taxes. Thus, because the state has the authority to disregard sham transactions, the transactions must be disallowed.

Summary of Conclusions Stated in Support of Courts Finding:

1. Accounting firm marketed same plan to other businesses.
2. Accounting firm stressed state tax savings in its materials.
3. Accountants knew the taxpayer needed a business purpose other than tax savings.
4. Accountants provided taxpayer with several sample business purposes.
5. Taxpayer did not follow through on achieving any non-tax business purpose.
6. Non-tax business purposes did not have economic substance, risk, or effect.
7. There was no increase in income, no lessening of expenses, no business, other than the avoidance of taxes.
8. Only business purpose achieved was state tax savings.

So What?

This is not the first time a state and/or court has disallowed a transaction because it determined the transaction lacked economic substance or business purpose (and it won't be the last time).

Therefore, when conducting any type of state tax planning (especially complex restructuring), make sure the “horse is in front of the cart.” Meaning, figure out what your business goals and objectives are, and then figure out what state tax planning can be done to minimize the state tax ramifications of achieving those business goals.

It's Official: Michigan Governor Signs Legislation Replacing the MBT!

I have discussed this legislation in earlier posts, but now it is official.

On May 25, 2011, Michigan Governor Rick Snyder signed legislation (H.B. 4361, 4362, 4479-4484, Public Acts 38-45) replacing the Michigan Business Tax (MBT) with a corporate income tax and making major changes to the state's individual income tax law. Effective January 1, 2012, the state's MBT will be replaced by a corporate income tax (CIT) imposed on only on businesses organized as C corporations under federal law. Sole proprietorships and pass-through entities such as partnerships, S corporations and limited liability companies currently taxed at the entity level under the MBT would not be required to pay taxes or file returns under the CIT. The term “corporation” under the CIT would not include an insurance company or a financial institution.


To access the bill, go to Michigan HB 4361.

State Tax Collections On the Rise!

The Wall Street Journal reported today that state tax collections are up! 

According to the article, state tax collections are growing, but they are still below pre-recession levels. 

As you may know, all or most states have large budget gaps and are in desperate need of more tax revenue. 

This growth in state tax collections helps close the gap, but states are still being forced to decide between raising taxes or cutting services. 

What will your state do?

No More Michigan Business Tax (MBT)??????

The Michigan Senate and House of Representatives have passed legislation to eliminate the infamous Michigan Business Tax (MBT) and create a new income tax on C corporations along with other changes.

The bills are HB 4361 and HB 4362.

The bills (or new tax) would take effect January 1, 2012.

House Bill 4361 (H-1) would amend the Income Tax Act, eliminating numerous credits, deductions and exemptions, as well as changing future tax rates. House Bill 4361 (H-1) also would create a new Corporate Income Tax, levied on businesses organized as traditional corporations under Federal law. House Bill 4362 (H-1) would amend the Michigan Business Tax (MBT) Act to allow certain taxpayers that wished to claim select credits allowed under current law to continue claiming those credits if they continued to file returns under the MBT. House Bill 4479 would amend the Multistate Tax Compact to remove the option for certain out-of-state taxpayers to apportion their tax base (under either the MBT or the proposed Corporate Income Tax) using an equally weighted three-factor formula instead of the 100%-sales factor formula specified in the MBT and the proposed Corporate Income Tax.

House Bill 4362 (H-1) would amend the MBT Act to provide for its eventual repeal and for certain taxpayers to continue to claim select credits. House Bill 4361 (H-1) contains complementary and duplicative provisions related to House Bill 4362 (H-1) and the option for certain taxpayers to continue to file a return under the MBT if they sought to claim certain credits.

Waiting for the Governor's Signature.

Where Should Your Company Relocate or Invest?

If your company is, or has been looking to relocate or invest in new operations and is not sure where to begin, then you may find the recent study put together by the Council On State Taxation (COST) and Ernst & Young, LLP extremely informative.

The study provides a state-by-state comparison of the tax liabilities that new investments in selected industries or types of economic activities would incur in each state.  The analysis focuses on capital investments in industries that have location choices, such as factories or headquarters, rather than those that are tied to a specific geography, such as retailers or hotels.

The study reflects a large difference in tax burdens among the states. Key findings include:

• Maine imposes the smallest burden on new investment due to factors such as a favorable corporate income apportionment formula that compensates for a relatively high tax rate, a property tax exemption for new equipment and low state and local sales tax rates.
• Oregon ranks second due to an advantageous corporate income apportionment formula and the absence of a sales tax on business inputs and franchise taxes.
• New Mexico’s state and local business tax system imposes the greatest burden of any state, resulting from factors such as a corporate income apportionment system that makes a large portion of the income from new investments taxable, an above average corporate tax rate and the imposition of a gross receipts tax on virtually all business activities.

You can review the study here.

The Michigan Business Tax: Killed on Friday the 13th?

Well, its Friday the 13th; which makes me think (more than usual) that I can't believe everything I read. 

With that said, according to recent activity in the Michigan legislature and the Michigan Chamber of Commerce website, the Michigan House and Senate have voted to repeal the Michigan Business Tax, otherwise known as the MBT.  The MBT replaced the ever-popular Single Business Tax or SBT a few years ago and has been under scrutiny ever since.

The MBT currently consists of three parts - a gross receipts tax, an income tax, and a surcharge.  The Michigan House and Senate legislation changes the MBT to a flat rate corporate income tax.  Apparently the income tax would only apply to C corporations.  Partnerships and S corporations would be exempt. 

It looks like 2011 is the last year for the MBT.

Stay tuned for more details!

Michigan Amnesty or Voluntary Disclosure: Don't Choose the Wrong One!

As I stated in an earlier post, Michigan has created an Amnesty program that runs from May 15 to June 30, 2011.  However, all taxpayers are NOT eligible to take advantage of this program.

Please note that Michigan’s Amnesty program does NOT apply to taxpayers that are eligible to enter into Michigan’s Voluntary Disclosure Program.

In simple terms, a taxpayer is eligible to enter into the Voluntary Disclosure Program if:

1. The taxpayer has not been contacted by Michigan,
2. The taxpayer has “nexus” or a taxable presence in Michigan, and
3. The taxpayer has not filed a tax return.

The Voluntary Disclosure Program has a four-year look-back period. The Amnesty program covers all tax periods prior to January 1, 2010. Therefore, the look-back period may be longer under the Amnesty program.

The Voluntary Disclosure Program is available year-round. The Amnesty program is only available between May 15th and June 30, 2011.

For more info on Michigan's Voluntary Disclosure Program, go to MI VDA.

Texas Franchise Tax: Hot Topics for 2011 Filings Due May 15th!

The Texas Comptroller's Office published what it thinks are the Hot Topics for the 2011 franchise tax filings in its recent Tax Policy News. 

The following items are addressed:

1. Franchise Tax Web Service
2. Passive Entity Reporting
3. Apportionment (single-sales factor vs. MTC 3-factor)
4. Temporary Credit Election
5. Extensions and Mandatory EFT
6. Combined Group Elections

In addition to the above, I would say that with Texas, you need to do everything you can to properly file all of the correct forms to avoid receiving a notice later.  Remember to file your public information reports along with the franchise tax return.  Also, if you are filing a combined return, remember to attach the correct affiliate schedule to the combined return. 

From a calculation standpoint, make sure to utilize the correct subtraction (wages, cost of goods sold or 30%) with the original return.   

If you are looking for an easy way to estimate your company's franchise tax liability, check out Texas' online calculator.

Texas also provides some additional guidance regarding what forms to file and how to E-file on its website.