Self-Employment Deduction in a Unitary Return
Last week I addressed the question of eliminating intercompany business income on a unitary return.
Following was my answer:
The law allows the members in a combined return to eliminate transactions between members of a “unitary business group”. So the general answer is YES, you do eliminate intercompany income and expenses (business income). However, eliminating expense of one member and income of another member merely washes out with no net tax effect. Therefore, the eliminations box on Form 4580, Page 4, Line 21 Business Income would be blank. Business income is not eliminated.
There are exceptions. If the members of a “unitary business group” have different year ends or different methods of accounting; there may be a net adjustment on Form 4580, Page 4, Line 21 Business Income. The adjustment may be positive or negative because it’s just a timing adjustment.
Now, what do you do if one of the members of a "unitary business group" has self employment income while the other does not and there are intercompany transactions. What if a LLC dental practice, reporting on a Schedule C as a disregarded entity, filed a combined unitary return with another LLC real estate company, reporting on a Schedule E as a disregarded entity. Can the Schedule E rental income be eliminated thereby making all the income qualified as self-employment income?
Back to my first paragraph above: The law allows the members in a combined return to eliminate transactions between members of a “unitary business group”. You eliminate intercompany income and expenses (business income). The effect is a wash on business income, but it will affect the self-employment income.
In our case, you would eliminate the rent expense (paid to the rental LLC) from the dental practice which would increase the business income and self-employment income for the medical practice. Then you eliminate the rent income (received from the medical practice) from the rental LLCs. After you are done, business income has not changed, however all the income is self-employment income. Remember the single taxpayer unitary theory.
All the income is self-employment income, so it would be reported on form 4580, line 31 column C, and then transferred to line 25d form 4567. But this isn't the amount of self-employment income reported on the taxpayer's Federal return? Don't the instructions for line 25d say to report the amount included in Federal Taxable Income?
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Matthew,
You bring up a good point. Section 201(1)(h) of the Michigan Business Tax Act provides the subtraction "to the extent included in federal taxable income, ... any earnings that are net earnings from self-employment as defined under section 1402 of the internal revenue code of the taxpayer..." Please note that the law does NOT say earnings on which self-employment tax was paid. When the intercompany transactions are eliminated, the remaining income, which was included in federal taxable income, is characterized as self-employment income even though self-employment tax was not paid on it.
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I have an issue in the opposite direction. The Designated Member (DM)is an S-Corp and is part of a unitary group with a disregarded entity LLC that reports on a Schedule C and generates self employment income for the Schedule C. When the intercompany transactions are eliminated is the self employment income of the LLC eliminated? Even though self employment tax was actually paid on the disregarded entity self employment income? Would choosing the disregarded entity LLC as the DM be a solution?
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The determination of who will be the 'designated member" has nonthing to do with the intercompany eliminations. In your example, if the intercompany elimination for the LLC, the disregarded entity filing on a Schedule C, was an expense paid to the S Corporation, then the amount of the self employment income would be increased. Therefore, the self-employment income deduction would be increased or greater than what it would have been on a separate return. The reverse could also be true.
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How would the unitary self-employment income deduction be affected by member's which have ordinary losses and self-employment income is reported as a negative number? Is the negative SE treated as zero for the deduction? Or do the member's with negative SE reduce the member's with positive SE income to produce a net SE deduction?
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Section 113(3) of the Michigan Business Tax Act (MBTA) defines a "person" broadly to include an individual among several other types of entities. Section 117(5) defines a taxpayer to include a "person" or a "unitary business group". Based on the above, I would presume the self-employment deduction in the business intome tax component of the MBT would be calculated on a combined or unitary basis other than on an enttity basis. Therefore, losses of one member would be offset against other members with profits to compute the net self-employment income for purposes of the deduction. In addition, the net self-employment income, for purposes of the deduction, should be computed after elimination of transactions between members of the unitary business group.
The instructions for Form 4580 are silent in regard to the two issues raised above. Therefore, we do not know Treasury's position on these two issues. They have not be consistent in treating a "unitary business group" as one person for all exemptions (agricultural), deductions (self-employment income) or credits.
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