Revenue Administrative Bulletin 2024-23

Note: A taxpayer may rely on this Revenue Administrative Bulletin (RAB) until it is revoked by Treasury or until a law on which this RAB is based is altered by legislation or by binding judicial precedent. See MCL 205.6a and RAB 2016-20.

RAB 2024-23. This RAB discusses how to compute federal taxable income (“FTI”), and the treatment of FTI, a net operating loss (“NOL”) and a business loss (“BL”) for purposes of computing corporate income tax (“CIT”) liability under Chapter 11, Part 2 of the Michigan Income Tax Act (“MITA”). The RAB will also discuss the reporting of these amounts on the Michigan CIT return (“Form 4891”). This RAB is limited to corporations reporting business income under Part 2 of the MITA and does not apply to insurance companies and financial institutions that are subject to different taxes under Chapters 12 and 13. MCL 206.635-659.

Analysis and Discussion:

Taxpayers that have nexus with Michigan and that have apportioned or allocated gross receipts of $350,000.00 or more and have a CIT liability more than $100.00 must file an annual return. MCL 206.685(1). Corporations pay tax on income. The corporate income tax base (“CIT base”) is based on business income subject to statutory adjustments before allocation and apportionment. MCL 206.623(2). Business income is defined as FTI and, for a tax-exempt taxpayer, only that part of FTI derived from unrelated business activity. MCL 206.603(3). Corporations should refer to RAB 2022-23 for discussion of unitary businesses under the CIT. The discussion that follows also applies to each member of a unitary business group (“UBG”) when computing a pro-forma return. See RAB 2022-23 for more information regarding computing a pro-forma return.

Federal Taxable Income:

FTI is the starting point for computing the CIT base. The Court of Appeals recently held this principle has a long history as the starting point for computing the tax base and also applied under the plain language of the prior Single Business Tax (“SBT”) and the Michigan Business Tax (“MBT”). See Republic Servs of Michigan Holding Co v Dep’t of Treasury, Mich App; NW2d (2024) (Docket No. 366164) and Michigan Bell Telephone Co v Dep’t of Treasury, Mich App; NW2d (2024) (Docket No. 365615) citing to Lear Corp v Dep’t of Treasury, 299 Mich App 533, 536; 831 NW2d 255 (2013). FTI is defined as taxable income defined in section 63 of the Internal Revenue Code (“IRC”) except that the calculation under the CIT requires taxpayers to decouple from sections 168(k) and 199 of the IRC. MCL 206.607(1). Thus, taxpayers that have first year bonus depreciation under section 168(k) or a domestic production activities deduction under section 199 will need to make those adjustments when computing FTI.

Example 1: Assume a taxpayer has FTI before depreciation of $20,000. The taxpayer purchases an asset that qualifies for bonus depreciation under IRC 168(k). The asset costs $20,000. Under the modified accelerated cost recovery system (“MACRS”) depreciation schedules, assume the taxpayer would be entitled to a $4,000 depreciation deduction in the year of purchase. For federal taxes, the taxpayer deducts the full acquisition cost as bonus depreciation reducing its FTI to zero.

Taxpayers must begin with federal FTI to compute CIT FTI. When computing the CIT FTI, the taxpayer must decouple from the bonus depreciation deduction included in federal FTI and only claim the allowable MACRS depreciation amount of $4,000. The reduced depreciation deduction results in $16,000 of FTI that is the starting point for computing CIT liability. CIT FTI is computed as follows: ($0 federal FTI + $20,000 addback bonus depreciation taken - $4,000 MACRS depreciation allowed = $16,000 CIT FTI).

Taxpayers must track, and keep records related to the differences between federal taxes and CIT that arise from the tax effects of decoupling from IRC 168(k) and 199 that will affect FTI used for future CIT liability computations.

Example 2: Assume the taxpayer sells the asset acquired in Example 1 for $6,000. Assume the remaining MACRS basis is $4,608. For federal taxes, the taxpayer will recognize a gain of $6,000 on the sale since the asset had been fully depreciated using bonus depreciation. Further, assume the taxpayer reported FTI of $11,000 that includes the gain on sale. Since the CIT decouples from bonus depreciation and the asset sold has a MACRS basis of $4,608, the taxpayer will only recognize a gain on sale of $1,392 ($6,000 proceeds - $4,608 remaining basis). The taxpayer must adjust the FTI from $11,000 to $6,392 for computing CIT due to the smaller gain recognized ($11,000 - $6,000 federal gain + $1,392 CIT gain).

FTI for CIT computations is based on the provisions in IRC 63. Thus, the CIT incorporates the federal rules in section 63 except for the decoupling provisions discussed above. IRC 63 defines “taxable income” as gross income minus the deductions allowed under Chapter 1 of the IRC. Therefore, the federal rules for claiming deductions under Chapter 1 are incorporated into FTI and are used for CIT calculations unless the IRC or Michigan law provides otherwise. For example, the IRC provides that the taxable income of a residual interest in a Real Estate Mortgage Investment Conduit (“REMIC”) cannot be less than the excess inclusion income (“EII”) for the taxable year. Thus, otherwise allowable deductions, including a NOL are not permitted to offset income to the extent the reported income is EII. IRC 860E(a)(3).

In rare instances, Michigan law will decouple from the IRC. In those instances, the Michigan statute will control the calculation of FTI for the CIT. For example, the Michigan Regulation and Taxation of Marihuana Act (Initiated Law 1 of 2018) (“MRTMA”) decouples from IRC 280E that disallows certain deductions. MRTMA allows the deduction of ordinary and necessary expenses incurred by marihuana establishments when computing CIT liability. In such instances, Michigan law should be followed. For more information, see RAB 2022-26 at Revenue Administrative Bulletin 2022-26 (michigan.gov).

Example 3: Taxpayer holds residual interests in REMICs. Chapter 1 of the IRC states that the EII from a REMIC cannot be offset by any NOL. Assume the taxpayer has EII of $10,000 and other income of $50,000. Further, assume the taxpayer has NOL carryforwards of $100,000. Even though the taxpayer has sufficient NOL to reduce FTI to zero, the taxpayer must recognize for federal taxes, taxable income of $10,000 equal to the EII. The taxpayer must also recognize the EII as FTI for starting the calculation of the CIT base. The $10,000 is reported in Part 1 of Form 4891, Michigan Corporate Income Tax Annual Return, and is the starting point for computing the CIT base. See Credit Suisse Holdings (USA), Inc v Dep't of Treasury, unpublished per curiam opinion of the Court of Appeals, issued May 16, 2024 (Docket No. 364746).

If the taxpayer is a UBG, each member, including the designated member (“DM”), is required to file Form 4897, Michigan Corporate Income Tax Data on Unitary Business Group Members, and compute its pro-forma business income. The income of each member reported on its Form 4897 will be combined and carried forward to Form 4891 that is filed by the DM. Each member will compute its FTI in the same manner as discussed above.

Net Operating Loss:

Once FTI is computed for CIT, it is then subject to statutory adjustments required under section 623 of the CIT. One adjustment requires the add back of an NOL deducted in computing FTI. MCL 206.623(2)(c).

Prior to the Tax Cuts and Jobs Act of 2017 (“TCJA”), PL 115-97, taxpayers could carry an NOL arising before 2018 back two years. For an NOL arising in tax years ending after 2020, most taxpayers could only carry an NOL forward. The Coronavirus Aid, Relief, and Economic Security Act (“CARES”), PL 116-136, provided for a special 5-year carryback for taxable years beginning in 2018, 2019 and 2020. Taxpayers should visit https://www.irs.gov for more information on NOLs.

In general, an NOL is the amount of allowed federal deductions that exceed gross income. NOLs are provided for in section 172 of the IRC. These federal rules allow a taxpayer to claim an NOL deduction in computing FTI. Thus, if a taxpayer claimed an NOL in arriving at FTI, that loss would be included in the amount of FTI used as the starting point for computing the CIT base.

Section 623 of the CIT, MCL 206.623, requires taxpayers to make several adjustments to FTI to arrive at the CIT base. Included as an adjustment is the requirement to add back any carryback or carryover of a federal NOL to the extent it was deducted in arriving at FTI. MCL 206.623(2)(c). If a taxpayer files an amended federal return to claim a federal NOL and files an amended CIT return reporting the lower FTI amount, taxpayers need to add-back the NOL claimed on the amended federal return.

Example 4: Continuing the facts from Example 3 above. Taxpayer has EII of $10,000 and other income of $50,000. The taxpayer has NOL carryforwards of $100,000 and deducts $50,000 of NOL against the other income of $50,000 so that only $10,000 of EII is reported as FTI on the federal return. On its CIT return, the taxpayer will report $10,000 of FTI and then must add back the NOL of $50,000 deducted in arriving at FTI so that a total of $60,000 is included in the CIT base. The add back will be reported in Part 1, Additions to Business Income on Form 4891.

Each member of a UBG that claimed an NOL in computing its FTI must add back the loss included in determining FTI and report it on Form 4897. If the member was part of a federal consolidated return, the federal NOL reported as an add back must be based on a pro-forma federal return for the member. The DM will combine the NOL reported by each member of the UBG and add back the total NOL on Form 4891. For more information, see RAB 2022-23, at Revenue Administrative Bulletin 2022-23 (michigan.gov).

Business Loss:

A CIT BL is not the same as a federal NOL or a MBT BL. A BL is defined as a negative business income taxable amount after allocation or apportionment. Only BLs incurred after December 31, 2011, may be deducted under the CIT. MCL 206.623(4). Therefore, any BL incurred under the former MBT may not be claimed on a CIT return. As discussed above, federal NOL must be added back to FTI as an adjustment whereas a BL will be a subtraction from the apportioned CIT base.

Taxpayers have a total of 10 successive years to utilize a BL before it expires. A taxpayer that recognizes a BL will carry the loss forward to the next succeeding year as a deduction to the apportioned CIT base, then successively to the next nine years or until the BL is used up. Id. The oldest BL is always consumed first against the CIT base to avoid the possibility of expiration.

Example 5: Taxpayer has a BL in year 1 of $23,000. In year two, the taxpayer claimed a NOL of $10,000 reducing FTI to $3,000. All income was realized in Michigan and no other adjustments are required. In computing FTI for CIT, the taxpayer must add back the $10,000 of NOL deducted to arrive at the $3,000 of FTI reported and may use $13,000 of the available BL to reduce the CIT base ($3,000 FTI + $10,000 NOL add back) to zero. The remaining BL of $10,000 may be carried forward for use in the remaining nine years or until used.

Example 6: Taxpayer has a BL of $19,000 that is in the tenth year after being recognized. The apportioned CIT base for the tax year is $17,000. In this case, the taxpayer may use $17,000 of the available BL to reduce the tax base to zero. The remaining BL of $2,000 may not be carried forward to the next successive tax year as it expires.

Taxpayers must keep sufficient records to support when the BL was realized, the amounts used, and the unexpired balances available to be carried forward.

UBG Considerations:

An entity that joins a UBG may bring its BL carryforward to the UBG. If the entity was part of a prior UBG, it will bring its share of the prior UBG’s total BL carryforward. The BL carryforward of the incoming member is reported on Form 4897 line 11 for use by the UBG.

Example 7: UBG has a BL carryforward total of $16,000 that was generated three years ago. Entity C joins the UBG in the current year and brings a BL carryforward of $3,000 it recognized last year. For the current year the UBG has apportioned CIT base of $17,000. The UBG will apply the oldest BL carryforward first, $16,000, and use $1,000 of the BL Entity C brought to the group. The remaining $2,000 BL from Entity C will be carried forward.

As noted above, the oldest BL is always consumed first against the CIT base regardless of whether it was generated by existing members of a UBG, brought to the UBG by a new member or acquired under IRC 381. If members of the UBG have a BL that were realized in the same tax year, and together the total BL exceeds the CIT base of the UBG, the BL of each member is used in proportion to the BL that member contributed. Any BL that is not utilized within the 10-year period after it was realized will expire and cannot be deducted.

Example 8: UBG has three members A, B and C. Member A has a BL of $6,000 and B has a BL of $3,000 both realized last year and carried forward to the current year. Member C joined the UBG in the current year and brings with it a BL of $1,000 that remains from a BL originally recognized 5 years ago. The UBG has a total BL of $10,000 available for the current tax year from the members. Total CIT base for the tax year is $7,000. The UBG will use the oldest BL of Member C first reducing the CIT base to $6,000 ($7,000 CIT base - $1,000 BL). Because Members A and B each realized BL in the same tax year, those losses will be used in proportion to the loss amount contributed. Of the total BL contributions, Member A contributed $6,000 or 2/3 of the total $9,000 BL the two members contributed. Member B contributed $3,000 or 1/3 of the total. The UBG will use $4,000 of Member A’s BL ($6,000 remaining CIT base x 2/3) and $2,000 of Member B’s BL ($6,000 remaining CIT base x 1/3) to zero out the remaining CIT base. Member A will carry forward its remaining $2,000 of BL ($6,000 BL - $4,000 BL used) and Member B will carry forward its remaining $1,000 of BL ($3,000 BL - $2,000 BL used) to the succeeding tax year.

When a member of a UBG contributed a BL to the UBG in a prior period then leaves the UBG, it will take its proportionate share of the remaining BL carryforward upon departure. The BL carryforward of the UBG is divided among the UBG and the departing members in proportion to the BL the members would have generated had each member filed separately. The portion of the BL carryforward attributable to a departing member is an amount equal to the BL carryforward of the UBG multiplied by a fraction, the numerator of which is what would have been the BL of that member had that member filed a separate return, and the denominator of which is the sum of what would have been the separate BL of all members of the UBG if those members filed separate returns.

Example 9: UBG ABCDE is comprised of Corporation members A, B, C, D, and E. The 2023 tax year generated an apportioned BL of $1,000 available for carry forward to the 2024 tax year. Due to a change in ownership, Corporation E is not part of the UBG for the 2024 tax year. If each member calculated their CIT base on a separate basis for 2023, only Corporations C, D, and E reported losses of $500, $700, and $300 respectively. For the 2024 tax year, Member E departs with a BL carryforward of $200 [($300/(500+700+300)) x $1,000]. UBG ABCD retains a BL carryforward of $800 available for tax year 2024.

UBG DM’s must be mindful that BL not used within 10 years will expire and some BL may be withdrawn by departing members. Taxpayers must keep sufficient records to support the reported BL carryforward. Generally, the BL carryforward will be maintained on the DM’s account with Treasury. Members of a UBG that realized a BL prior to joining a UBG will have the loss maintained on its account for use by the UBG until fully used. For more information, please see the instructions for CIT Forms 4890, 4891 and 4897 at Business Tax Forms (michigan.gov)