The Michigan Business Tax definition of shareholder found in Section 115(2) includes stock indirectly owned by or for family members as defined by Section 318(a)(1) of the Internal revenue Code (IRC).  There has been much confusion over this issue as well as the "active shareholder" issue.  The following is provided to hopefully clear up the confusion.

"Shareholder" means a person who owns outstanding stock in a business or is a member of a business entity that files as a corporation for federal income tax purposes. An individual is considered as the owner of the stock owned, directly or indirectly, by or for family members as defined by section 318(a)(1) of the internal revenue code.  [MCL 208.1115(2)]

Section 318(a)(1)(A) provides that an individual is deemed to own stock owned (directly or indirectly) by his or her:

• spouse

• children

• grandchildren

• parents

For purposes of Section 318(a)(1)(A)(ii), attribution of shares from children includes those held by legally adopted children. [Section 318(a)(1)(] For purposes of that Section, the term “lineal descendants” includes legally adopted children and grandchildren. Without legal adoption by the step-parent, there is no attribution of shares from step-children to a step-parent or to step-grandparents. In addition, without legal adoption of the child, there is no attribution from a step-parent to step-children.

While a grandparent is deemed to own shares owned by his or her grandchildren, the grandchild is not deemed to own shares owned by his grandparents. [Income Tax Regulations Section 1.318-2(b)]

There is no attribution of stock between siblings under Section 318(a)(1). Attribution of stock is limited to close family members. Moreover, aunts, uncles, nieces, nephews, and cousins are not within the purview of these attribution rules.

The Section 318 attribution rules aim to expand the concept of stock ownership in order to achieve the purposes of the numerous provisions for which they apply. This typically results in deemed ownership of all or a portion of the outstanding stock of a corporation by multiple related parties.

Under Section 318(a)(5)(, there is no double attribution of stock among family members. This means that if an individual is deemed to own stock from a family member by virtue of the Section 318(a)(1)(A) family attribution rules, ownership of those shares may not be attributed to another family member under those same rules. Thus, there is no attribution from one family member to another and then to another under Section 318(a)(1)(A).

IRC Section 318(a)(2) provides for attribution from partnerships, estates, trusts and corporations.  IRC Section 318(a)(3) provides for attribution to partnerships, estates, trusts and corporations.  However, the MBT definition of “shareholder” [MCL 208.1115(2)] limits use of the term “indirectly” to Section 318(a)(1). It does not reach down to Section 318(a)(2)( or Section 318(a)(3).

The 2008 Michigan Business Tax Annual Return Form 4577 Schedule of Shareholders and Officers must be completed to list the appropriate shareholders and officers:  Column E must list the percentage of stock owned directly.  Column F must list the percentage of stock owned indirectly with attribution.  If no attribution exists, enter the percentage from column E in column G and leave column F blank.  Column F should be filled out only if and when attribution exists. 

The MBT law specifies that there is no attribution between “active shareholders”.  [MCL 208.417(2)]  The term “active shareholders” is defined in Section 417(9)((a) to include a shareholder who receives at least $10,000 in compensation and who owns at least 5% of the outstanding stock. [MCL 208.417(9)(a)]

Column G will include attribution of ownership only from, or to, family members who are not active shareholders.

All of the above is extremely important because it could impact the Small Business Alternative Credit.