Michigan Business Tax Treatment of a Cancellation of Debt
It must be a sign of the times, but we have received many questions on how to treat a cancellation of indebtedness as it relates to the Michigan Business Tax (MBT). David George, CPA of Troy provides the following explanation.
When a LLC (partnership) has a debt for debt exchange and realizes cancellation of debt income; the debt forgiven is included in gross receipts calculation for MBT in the amount of benefit it derived. See Treasury FAQ B21 and FAQ M42.
If the company retains the assets and reduces the basis as provided by IRC Section 108 we will have ITC recapture. The debt forgiven is the deemed selling price and gain would be zero assuming basis is greater than the COD income.
If the company does not retain the assets the total amount of the gain including the COD Income would be subject to the MBT business income tax calculations, and ITC recapture rules would be applicable.
Regardless the COD income would be included as part of the gross receipts.
The following is provided from Treasury FAQ B21:
A taxpayer who meets the nexus standards and gross receipts thresholds of the MBT act is subject to a business income tax imposed on the business income base of the taxpayer and a modified gross receipts tax imposed on the modified gross receipts tax base of the taxpayer. MCL 208.1201 and 1203. The business income tax base of a taxpayer means the business income of the taxpayer subject to a series of specific adjustments listed in section 201. MCL 208.1105(2) defines business income, in part, to mean “that part of federal taxable income derived from business activity. For a partnership or S corporation, business income includes payments and items of income and expense that are attributable to the business activity of the partnership or S corporation and separately reported to the partners or shareholders. . .”. (Emphasis added).
Here, the partnership has both COD income that is attributed to the business activity of the partnership (i.e. forgiveness of a debt secured by a partnership asset used in the business) and capital gain attributed to the business activity of the partnership (i.e. sale of the same partnership asset) that are separately reported to the partners on the federal K-1 form. While both capital gain and COD income are excluded from the calculation of partnership taxable income on the federal 1065 form, they are both income of the partnership separately reported to the partners on the K-1 forms, and fall within the plain meaning of business income of a partnership as defined in MCL 208.1105(2), regardless of the ultimate taxability of the COD at the partner’s level.
For the calculation of the modified gross receipts tax base under section 203 (MCL 208.1203), gross receipts is defined under section 111 (MCL 208.1111) to mean “the entire amount received from any activity whether in intrastate, interstate, or foreign commerce carried on for direct or indirect gain, benefit, or advantage to the taxpayer or to others,” subject to specifically enumerated exceptions. COD income and capital gain of a partnership that are separately reported to the partners are not one of the specifically enumerated exceptions, and are therefore subject to the modified gross receipts tax imposed under section 203 of the MBT.
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