October 2007 Subject: State and Local Michigan Business Tax and Deferred Tax Tax Alert Implications The Tax Practice at BDO Seidman, LLP is Summary among the largest tax advisory practices in Effective January 1, 2008, the Michigan Single Business Tax will be the United States. With 35 offices and more replaced by the new Michigan Business Tax. The financial reporting than 300 independent alliance firm locations requirements of this new tax might catch taxpayers off guard if in the United States, BDO Seidman has the attention is not given to the possible deferred tax implications of the bench strength and coverage to serve you. imposition of this new tax. Additionally, in order to take full For more information, please contact: advantage of the financial statement relief just enacted by the Michigan Legislature, taxpayers should start analyzing the impact of Richard Spengler, Partner this new tax now. BDO Seidman, LLP 99 Monroe Avenue NW Suite 800 Background Grand Rapids, MI 49503 On July 12, 2007, the new Michigan Business Tax (“MBT”) was (616) 776-3687 signed into law, effective for business activity after December 31, firstname.lastname@example.org 2007 (see BDO Seidman Alert dated July 2007: New Michigan Business Tax Signed into Law at Andrea Collins, Senior Manager http://www.bdo.com/about/publications/tax/alerts/TaxAlert- BDO Seidman, LLP MIBusTax.pdf). There are two components of the new MBT: the 99 Monroe NW Suite 800 Grand Rapids, MI 49503 business income tax (“BIT”) and the modified gross receipts tax (616) 774-7000 (“MGRT”). For FAS 109 purposes, it is BDO Seidman’s position that email@example.com both the BIT and MGRT are income taxes. With the imposition of any new tax that is considered an income tax for FAS 109 purposes, To ensure compliance with Treasury Department deferred taxes must be calculated for the cumulative difference regulations, we wish to inform you that any tax advice between book and tax basis for all assets that are considered in the that may be contained in this communication (including any attachments) is not intended or written calculation of the new tax. Additionally, the impact of the cumulative to be used, and cannot be used, for the purpose of (i) effect must be booked at the end of the financial reporting period avoiding tax-related penalties under the Internal including the enactment date of the tax, July 12, 2007. However, Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recently, an amendment to the MBT was passed that allows for relief recommending to another party any tax-related from possible detrimental impacts on the financial statement of any matters addressed herein. net deferred tax liability due to the imposition of the new tax. Material discussed in this tax alert is meant to provide general information and should not be acted on Income Tax Deferreds without professional advice tailored to your firm's While some taxpayers have treated the MSBT (the tax to be replaced individual needs. by the new MBT) as an income tax for financial statement purposes, most have treated it as an above-the-line, non-income tax. For taxpayers that previously considered the MSBT an income tax, the calculation of the deferred taxes associated with the enactment of the BIT component of the new MBT will entail increasing the rate used from 1.9% to 4.95%, and adjusting for any apportionment changes, as appropriate. However, for most taxpayers, a completely new deferred tax amount will have to be calculated. In general, any book-tax difference in the basis of assets results in a deferred tax asset or liability. If an asset has a higher book basis, there will be higher taxes due in the future since the tax deductions have been larger in the past. This results in a deferred tax liability being booked for financial statement purposes to reflect the higher tax that will be paid in the future. If an asset has a higher tax basis, there will be lower taxes due in the future since tax deductions have been lower in the past as compared to the book deductions taken. This results in a deferred tax asset being booked for financial statement purposes to reflect the lower tax that will be paid in the future. For the new BIT component of the MBT, the book-tax differences in the basis of assets will typically be the same as the differences that taxpayers are already booking for federal and other state income tax purposes. While there are possible differences between federal and state income tax basis (e.g. state de-coupling from bonus depreciation), the majority of temporary Schedule Ms will also be ones for which deferreds will need to be calculated for the BIT portion of the MBT. Depending on how a taxpayer currently calculates its state deferred taxes, the same methodology could be followed in accounting for the BIT component of the MBT. Another way to determine the deferred taxes associated with the implementation of the new BIT is to take the items on the balance sheet at the end of the fiscal reporting period and calculate the difference in book and tax basis. The total difference will then be multiplied by the estimated apportionment percentage under the new MBT (note that MBT apportionment is calculated on a combined basis for unitary business groups, is 100% sales factor, and there are new sourcing rules for sales other than tangible personal property) and then the BIT rate of 4.95%. This methodology will likely be the preferred method due to a new deduction that has recently been enacted and will be available in future years (see discussion below). Modified Gross Receipts Tax Deferreds For the MGRT component of the new MBT, the associated deferred taxes will also need to be calculated by identifying the difference between the book and tax basis of each asset on the books at the end of the fiscal reporting period. There are two main differences in calculating the deferred taxes for the MGRT, as compared to the BIT, besides the rate used: (1) the tax basis in the assets; and (2) the assets for which the book-tax difference should be calculated. Even though the book basis of an asset will be the same for BIT and MGRT purposes, the tax basis between the two taxes will be different. The tax basis for the MGRT will be zero for all assets on the books as of any period prior to January 1, 2008. This is because of how the MGRT base is calculated. The MGRT base takes a “person’s” entire gross receipts, with some exclusions, and then allows a deduction for “purchases from other firms.” Purchases from other firms includes inventory, fixed assets, materials and supplies, and any other tangible or intangible property that is subject to amortization, depreciation, or other capital cost recovery method for federal income tax purposes. Even though the MBT does not go into effect until January 1, 2008, the qualified assets on the books prior to then would have been allowed as a deduction as a “purchase from other firms” when acquired. Since a tax deduction theoretically would have been allowed in the past and will not be allowed in any future period, there is no MGRT basis for these assets. This effect is caused by the fact that the deduction for “purchases from other firms” is allowed immediately in contrast to the method of accounting that most taxpayers are on for book and tax purposes, the accrual basis. Since the MGRT basis for each of these assets is zero, there cannot be a deferred tax asset associated with the MGRT, only a deferred tax liability. Since the acquisition of only certain assets (ones that fit the definition of “purchases from other firms”) can be deducted from the MGRT base, only these assets should be reviewed to determine the book-tax basis difference. As mentioned above, inventory, fixed assets, materials and supplies, and any other tangible or (continues on next page) intangible property that is subject to amortization, depreciation, or other capital cost recovery method for federal income tax purposes are ones that will generate deferred tax liabilities. However, items such as cash, accounts receivable, and land are some of the assets that are never deductible under the MGRT and thus constitute permanent book/tax differences instead of impacting the deferred tax accounts. This is because even if they were acquired after the MBT was in effect, there would be no deduction allowed for them from the MGRT base. Once the book-MGRT basis differences are determined, the deferred tax liability would be calculated by multiplying the total difference by the estimated apportionment percentage under the new MBT and then by the MGRT rate of 0.8%. This initial booking of the deferred tax impact of the new MBT can be viewed as a one-time “catch-up” financial statement entry. Once the cumulative impact has been booked, the amount of deferred taxes will be adjusted in each future fiscal reporting period to reflect the book-tax differences. On the BIT component, deferred tax assets and liabilities will be adjusted in similar ways to federal and/or other state income taxes. For the MGRT component of the MBT, because an immediate deduction is allowed for each “purchase from other firms,” there will continue to be no MGRT basis in those assets. If the assets are purchased in a given fiscal reporting period, but have not been fully expensed for book purposes by the end of that fiscal reporting period, a deferred tax liability will be recorded. Relief for Deferred Tax Impact On September 30, 2007, House Bill 5104 was passed and provides for relief for taxpayers that have a net deferred tax liability impact to their financial statements as a result of the enactment of the MBT. The bill allows an MBT taxpayer to claim a future deduction against its BIT base that is calculated using the taxpayer’s current apportionment and tax rates and is set at a level that will create a tax benefit in the future equal to the net deferred tax liability recorded related to enactment of both the BIT and MGRT. Because the deduction will be allowed on future MBT returns, a taxpayer should record a deferred tax asset equivalent to the net deferred tax liability required in the cumulative effect entry. The result is that there should be no negative financial statement impact as a result of the enactment of the new MBT (i.e. no current year tax provision detriment). Any future deferred tax entries will be the result of timing differences between book and tax deductions, changes in the taxpayer’s apportionment percentage or MBT tax rates. The net deferred tax relief provision is a one-time deduction/entry that is only intended to offset the negative effects on a taxpayer’s deferred tax accounts as a result of the enactment of the MBT but will not affect annual changes to the MBT deferreds that result from changes in the taxpayer’s facts. As discussed above, if a person subject to the MBT has a book-tax difference at the end of the first fiscal year including July 12, 2007 that results in a deferred tax liability, the person is allowed a future deduction over a period of 15 tax years, beginning with the 2015 tax year. The deduction is equal to the following: • 4% of the book-tax difference, for tax years 2015 through 2019 • 6% of the book-tax difference, for tax years 2020 through 2024 • 10% of the book-tax difference, for tax years 2025 through 2029. The deduction is limited to the amount necessary to offset the deferred tax liability related to adoption of the MBT. The book-tax difference in assets is allowed to only be used once for the BIT and once for the MGRT. The amount of the deduction is the gross amount of the book-tax difference, without any federal income tax effect. If the adjustment is greater than the BIT base for a particular year, any excess deduction is allowed as a carryforward to a future year as a deduction before apportionment. No limitation on the carryforward period has been provided. Additionally, there appears to be no provision for taxpayers who are only subject to the MGRT (i.e. a taxpayer that is immune from the BIT because of P.L. 86-272). If a taxpayer is not subject to the BIT, there appears to be no relief provided for the financial statement impact of the imposition of the MGRT. (continues on next page) House Bill 5104 indicates that the Michigan Department of Treasury may require taxpayers to report the amount of the deduction on a specific form to be developed. If there is such a requirement, the deduction may be reported on the form due on or after the date the first quarterly return and estimated payment is due for the MBT, which is due on the 15th day of the fourth month following the end of a taxpayer’s fiscal year. How BDO Seidman Can Help With the enactment of the new MBT, every MBT taxpayer will have new deferred taxes that are required to be recorded. Booking the deferreds related to the BIT component of the MBT might be as simple as adjusting the rate at which current deferred taxes associated with the Michigan Single Business Tax were determined (i.e. from 1.9% to 4.95%). However, since most taxpayers did not consider the MSBT an income tax in the past, all new deferreds will be required to be calculated and booked in the first fiscal reporting period including July 12, 2007. While booking deferreds related to the BIT component might seem fairly straightforward to many taxpayers, booking deferreds related to the MGRT can be much more complex. Additionally, with the passage of House Bill 5104, it becomes even more important to capture all of the possible deferred tax liabilities associated with the implementation of the new MBT. Once the deduction amount is reported to the Michigan Department of Treasury, it does not appear that any modification will be allowed. BDO Seidman state tax professionals are available to assist taxpayers in identifying all of the assets that would have related book-tax differences for both the BIT and MGRT components of the tax, and calculating the associated deferred taxes and deduction amount to report to the Michigan Department of Treasury.
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