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Michigan issues guidance for UBG members computing pro-forma federal taxable income
December 2022
In brief
The Michigan Department of Treasury on December 6 issued a Revenue Administrative Bulletin (RAB) addressing the computation of pro-forma taxable income for Unitary Business Group (UBG) members that file a federal consolidated return.
The RAB provides that each UBG member computes federal taxable income (FTI) separately and states that differences between Michigan’s FTI starting point and FTI that is computed federally may exist due to reasons such as the state not following federal consolidated return regulations and state statutory modifications from FTI.
The RAB notes that member composition of a UBG may differ from a federal consolidated group for several reasons, including (1) different ownership requirements for each and (2) entity exemptions from either the UBG or federal group, but not from both.
Finally, the RAB addresses reporting requirements for the CIT affiliate group filing election.
The takeaway: The Department’s issuance of its RAB on the differences between the pro-forma computation for UBG’s as compared with federal consolidated returns provides taxpayers additional clarity on the Department’s June 2020 guidance on the computation of the interest expense limitation under IRC section 163(j) for Michigan purposes.
Action item: When preparing Michigan CIT returns, taxpayers should consider the impact of Michigan’s pro-forma approach to computing taxable income and how that may differ from its calculations from a federal tax perspective. Further, taxpayers should review their previously filed CIT returns to determine the impact this guidance could have on returns that are open under Michigan’s four-year statute of limitations.
[Michigan Department of Treasury, Revenue Administrative Bulletin 2022-23, Computing Pro-forma Federal Taxable Income for Unitary Business Group Members that File a Federal Consolidated Return (12/6/22)]
In detail
The RAB “focuses solely on the pro-forma calculation of FTI that is the starting point for computing the tax base of each corporation that is a member of a UBG that files a standard combined return.” The following summarizes the Department’s guidance provided in the RAB.
Michigan combined vs. federal consolidated filings
The Michigan Corporate Income Tax (CIT) requires a UBG to file a combined return. The Department has “consistently recognized that consolidated and combined filing are not the same” and has required each UBG member that is included on a federal consolidated return to separately compute a pro-forma federal return to determine its pro-forma federal taxable income.
Pro-forma FTI calculation
Members of a UBG each must compute a pro-forma FTI as a single person. The pro-forma FTI amount is subject to statutory adjustments to arrive at the UBG member’s tax base and, ultimately, the UBG’s combined CIT liability. For this purpose, FTI generally is defined as taxable income defined in IRC Section 63, with certain exceptions (e.g., Sections 168(k) and 199).
The RAB concludes that the CIT does not follow the federal consolidated return regulations because “those regulations are outside of the chapter 1 definition of FTI.”
As noted above, each UBG member must be treated as a single person; thus, a pro-forma FTI calculation must be made by each member. Each member’s pro-forma FTI is reported on Form 4897, and amounts for all members are summed together to determine the UBG’s combined FTI. Because of differences in the federal regulations and the CIT, the combined pro-forma FTI of a UBG will not necessarily equal the FTI on the federal consolidated return, even if membership in the two returns is the same.
The RAB provides an example whereby UBG members compute FTI without using the federal consolidated investment rule treatment. The Department concludes that “[b]ecause the CIT computes FTI under IRC section 63 . . . the consolidation rules under chapter 6 are not taken into account.”
A second example highlights the different FTI calculations required for Michigan purposes due to bonus depreciation adjustments and UBG group member composition different than that of the federal consolidated group. The RAB provides that the examples “illustrate both the difference in composition between a consolidated group and a UBG as well as adjustments that must be made in computing each member’s FTI under the CIT. The pro-forma FTI of each member of the UBG is subject to the statutory adjustments . . . and is the starting point for computing the tax base of each member.”
Group member differences
The Department cautions that taxpayers must carefully review the ownership and relationships of owned entities when determining the members of a UBG, as the composition of a consolidated group and a UBG may differ.
Group member differences may occur as a result of a federal consolidated group generally requiring 80% ownership whereas a UBG generally requires more than 50% ownership. The RAB notes the following potential differences in group composition:
- Members of a federal consolidated return may not be the only members required to be included in a UBG’s return. For example, entities not satisfying the 80% federal ownership test nevertheless may be members of a UBG if they satisfy the 50% ownership and other UBG requirements.
- Entities not part of the federal affiliated group may be required to be included as a member in a UBG if control and one of the alternative relationship tests are satisfied.
- Foreign operating entities may be included in a federal consolidated return but are specifically excluded from the definition of UBG.
- Not all tax-exempt corporations excluded from a federal consolidated return are exempt from the CIT.
The Department notes that “[e]ach entity [of the UBG] will need to compute its pro-forma FTI as the starting point for computing its tax base that will be combined with the other members’ tax bases for the UBG return.”
Affiliated group election
The CIT allows affiliated groups to elect to file as a UBG. The election does not require the Department's consent, but a taxpayer must provide notice to Treasury of its election on Form 4891, line 7b. Once made, each person in the affiliated group is bound by the election, including renewals, and waives any objection to inclusion in the affiliated group and treatment as a UBG. If a person enters the affiliated group after the tax year the election is made, that person is deemed to have consented to the election and is bound by it.
The election is irrevocable for a total of 10 years and is renewable in 10-year increments. However, if not renewed, a new election is not permitted in any of the immediately following three tax years. The election remains in effect if the ownership requirements are met, regardless of whether a federal consolidated group to which the UBG belongs discontinues filing a federal consolidated return or the common parent changes due to a reverse acquisition or acquisition by a related person.
Each member of the UBG will calculate its pro-forma FTI that will be used in the calculation of its tax base. Each member’s tax base will be combined to determine the tax liability of the UBG.
Section 163(j) treatment
The Department advanced its UBG member separate FTI calculation in a June 8, 2020, Notice specifically addressing the business interest expense limitation under IRC Section 163(j). The Notice provided that, despite the results of the federal consolidated return, each pro forma corporation subject to the limitation federally must separately calculate (like the other components of FTI) a pro-forma business interest expense amount to arrive at its pro forma FTI. The December 6 RAB summarized here memorializes this concept more broadly by concluding that the federal consolidated return regulations do not apply generally to the CIT.
Note: S.B. 195, which passed both houses of the Michigan Legislature on December 7, 2022, would not subject a taxpayer to the Section 163(j) limitation for various reasons, including if the taxpayer is a member of a federal consolidated group that “is not limited under Section 163(j)(1).” If enacted, the bill would be applicable to tax years beginning on and after January 1, 2022. If the governor signs the bill, we will update this Insight and issue a separate Insight summarizing the bill.
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