Business Income Taxation - Individual Income Tax FAQs

Michigan defines business income as all income arising from transactions, activities, and sources in the regular course of the taxpayer's trade or business. Business income includes a taxpayer’s distributive share of income or losses reported on a federal schedule K-1, including portfolio income.  Portfolio income includes interest income, dividend income, royalty income, and net short-term and long-term capital gains (losses) to the extent included in federal adjusted gross income.  Rental income is also considered business income if it is determined to be an integral part of the taxpayer’s trade or business.  The statutory definition of business income can be found in MCL 206.4

Business income is taxable in Michigan based on the location of the business activity.  Business income or loss is allocated and apportioned under the provisions in Part 1, Chapter 3 of the Michigan Income Tax Act.  

• If the business activity occurred solely in Michigan, the entire business income or loss is allocated to Michigan. MCL 206.102
• If the business activity occurred both within and outside of Michigan, the Michigan business income or loss is determined using Michigan’s method of apportionment. MCL 206.105 Business income apportioned to Michigan is computed on the Michigan Schedule of Apportionment (Form MI-1040H).  MCL 206.115 provides that all business income shall be apportioned to Michigan by multiplying the business income or loss included in adjusted gross income (AGI) by the Michigan sales factor for years beginning in 2012 and after.*                      
  
  Business income apportioned to Michigan is taxable to Michigan.  Business income not apportioned to Michigan may be claimed as a subtraction from AGI.  Conversely, business losses not apportioned to Michigan cannot reduce Michigan taxable income and must be added to AGI.

• If the business activity occurs entirely outside of Michigan, the business income may be subtracted from AGI. Conversely, losses from business activity that occurs entirely outside of Michigan cannot reduce Michigan taxable income and must be added back to AGI.

*For years 2011 and earlier business income was apportioned using a three-factor apportionment formula.

Beginning in 2012, business income or loss generated from business activity both within and outside of Michigan is apportioned to Michigan using a single sales factor, the ratio of the business’ Michigan sales to the business’ total sales.*

Business income or loss apportioned to Michigan is computed on the Michigan Schedule of Apportionment (Form MI-1040H).  Business income apportioned to Michigan is taxable to Michigan.  Business income not apportioned to Michigan may be claimed as a subtraction from adjusted gross income (AGI).  Conversely, losses not apportioned to Michigan cannot reduce Michigan taxable income and must be added to AGI.

Taxpayers who are apportioning business income must complete a separate Form MI-1040H for each business entity unless an eligible taxpayer elects to combine apportionment of unitary businesses.

There are special apportionment formulas for transportation companies and other authorized taxpayers.  See “Does every type of business use the single sales factor for apportioning business income to Michigan?” 

Please see the Michigan Schedule of Apportionment (Form MI-1040H) under Individual Income Tax Forms and Instructions.

*For years 2011 and earlier business income was apportioned using a three-factor apportionment formula.

To compute the sales factor, divide the total sales in Michigan during the tax year by the total sales everywhere during the tax year.  The sales factor is generally computed for each business entity separately. Complete a Michigan Schedule of Apportionment (Form MI-1040H) for each business entity, unless the eligible taxpayer has elected to combine apportionment of unitary entities.  MCL 206.121

“Sales” are the gross receipts from sales of tangible property, rental property, and services that constitute business activity.  MCL 206.20 defines Michigan sales as, “all gross receipts of the taxpayer” not allocated to another state.

Sales of tangible personal property are in Michigan if:

(1) The property is shipped or delivered to a purchaser (other than the United States government) within Michigan regardless of the free on board (F.O.B.)  point or other conditions of the sale; or

(2) The property is shipped from an office, store, warehouse, factory or other place of storage in Michigan and the purchaser is the United States government or the taxpayer is not taxable in the state of the purchaser.  MCL 206.122

When determining the sales factor of a tangible product the Michigan sales are reported in the numerator and total sales everywhere are reported in the denominator on the Michigan Schedule of Apportionment (Form MI-1040H).  Note:  The numerator of the sales factor may include “throwback sales”.

Sales of other than tangible personal property (e.g., services, trademarks, patents, and royalties) are in Michigan if:

(1) The business activity is performed in Michigan; or

(2) The business activity is performed both in Michigan and in another state(s) and a greater proportion of the business activity is performed in Michigan, based on costs of performance.

When income from the sale of intangible products is subject to apportionment, Michigan “sales” and total “sales” are determined using the cost of performance method. Each sale is viewed separately on a job-by-job or contract-by-contract basis. If the majority of the cost to perform a job or contract occurred in Michigan, then that specific intangible sale would be considered a Michigan sale.  Michigan sales are reported in the numerator and total sales everywhere are reported in the denominator on the Michigan Schedule of Apportionment (Form MI-1040H). 

Throwback sales are sales of tangible personal property made to a purchaser in another state or country, which originate in Michigan, and are “thrown back” into the numerator as a Michigan sale in the computation of the Michigan sales factor because the income from the business is not taxable by the other state or country.

For purposes of allocation and apportionment of income from business activity under Part 1, Chapter 3 of the Michigan Income Tax Act (individual income tax), a taxpayer is taxable in another state if:

(1) In that state the taxpayer is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business or a corporate stock tax; or

(2) That state has jurisdiction to subject the taxpayer to a net income tax regardless of whether, in fact, the state does or does not.

Generally, to exclude sales originating in Michigan and made to purchaser in another state or country from the numerator, the business must have a physical presence in the other state (nexus) and the activity in that state must be beyond mere solicitation of sales.

Taxpayers with business income/loss included in adjusted gross income are required to provide information regarding the type and location of that income.  The Business, Rental, and Royalty Activity Worksheet can be used to identify the location of Michigan and non-Michigan business and rental activity. It also can be used to identify other non-business income as Michigan or non-Michigan income. The Worksheet is a suggested attachment to a return for required information and can be used by e-filers or paper filers.  The Worksheet can be found online with the Michigan individual income tax forms.  The Worksheet, or any similar worksheet that identifies the type and location of non-Michigan business activity and income, may be attached as a PDF file to an e-filed return using the file name "BusinessActivity.pdf." The Worksheet or similar worksheet may also be included with any paper filed return.

No; there are special apportionment formulas for transportation companies and other authorized taxpayers.  Those formulas are identified in Part 1, Chapter 3, sections 131 - 134 of the Michigan Income Tax Act. MCL 206.195 allows a taxpayer to request an alternative apportionment, see RAB 2018-28 further details.

Yes, in 2013 the Michigan Supreme Court held that combined apportionment of income (loss) at the entity level may be used to calculate individual taxable income at the election of the taxpayer.  Malpass v Department of Treasury, 494 Mich 237 (2013).

A taxpayer may elect to apportion each discrete legal entity’s income (loss) separately or to combine apportionment when entities are unitary.  To be a unitary business, the taxpayer must have control over the entities included in the combined apportionment filing and a flow of value must exist between the entities.  Factors that establish a flow of value include:

• Economic realities
• Functional integration
• Centralized management
• Economies of scale
• Substantial mutual interdependence

These factors are not exhaustive or exclusive and the ability to elect combined apportionment will depend on the totality of the circumstances.

If a taxpayer elects to file using combined apportionment it means companies operating as a unitary business are treated as if they are one company for apportionment purposes.  The sales factor is determined as a ratio of the combined Michigan sales and combined total sales, after the elimination of intercompany sales, of all entities that are unitary.  The sales factor ratio is applied to the combined income (loss), included in adjusted gross income, of all the unitary companies.

A unitary relationship exists when a taxpayer has control over the entities and the entities have a flow of value between their various operations.  Factors that establish a flow of value include:

• Economic realities
• Functional integration
• Centralized management
• Economies of scale
• Substantial mutual interdependence

These factors are not exhaustive or exclusive and the ability to elect combined apportionment will depend on the totality of the circumstances.

The sales factor is computed using Part 1 of the Michigan Schedule of Apportionment (Form MI-1040H).  Generally, for the numerator, all the Michigan sales of every company in the unitary group are combined to arrive at Michigan sales.  For the denominator, the total sales of every company in the unitary group are combined to arrive at total sales.   When calculating the Michigan sales and the total sales of each company, intercompany sales are eliminated.  In addition, each company's Michigan sales and total sales are multiplied by the individual taxpayer's ownership interest percentage in the corresponding company.  The taxpayer must have common control over the entities included in the combined apportionment filing.  The business income (loss) from all the companies in the group, net of intercompany eliminations, is combined to arrive at business income subject to apportionment in Part 2 of the MI-1040H.

A worksheet identifying the members in the combined apportionment group showing the combining calculations must be included with the MI-1040H filed with the MI-1040 return. The worksheet may be attached as a PDF file to an e-filed return using the file name "UnitaryCalculation.PDF."  A sample MI-1040H Unitary Apportionment worksheet can be reviewed on the Treasury Individual Income Tax Forms webpage.