Michigan: Court of Appeals Approves Use of Alternative Apportionment Formula (Again)

Listen to a brief overview of state tax developments this week, including Michigan, or read full Michigan development below.

Detailed Michigan Development

On September 30, 2021, the Court of Appeals of Michigan held once again that a taxpayer was entitled to use an alternative apportionment formula because the statutory formula did not fairly reflect income earned within the state. This conclusion mirrors the court’s 2020 opinion in the same case that was later remanded for further review by the Supreme Court of Michigan. The taxpayer, an S-corporation headquartered in Minnesota, was engaged in the business of constructing, maintaining, and repairing oil and gas pipelines. During the year at issue, Michigan taxed S-Corporations at the entity level. The taxpayer operated in 24 states, including periodically in Michigan, but never maintained a permanent business location or retained permanent employees in Michigan. In the same year in which the taxpayer was working on a large project in Michigan, the  shareholders sold all of their stock in taxpayer and elected under IRC § 338(h)(10) to treat the sale of stock as the taxpayer’s sale of all of its assets. On its Michigan Business Tax return for the tax year at issue, the taxpayer included the gain from the sale in its tax base and in the denominator of its sales factor, which resulted in a sales factor of about 15 percent. On audit, the Michigan Department of Treasury determined that the taxpayer improperly included the gain in the sales factor denominator. This increased the taxpayer’s sales factor to approximately 70 percent. At that point, the taxpayer requested that it be allowed to use an alternative apportionment formula and made certain other arguments that the gain should not be taxed as the Department proposed.

On appeal from the Michigan Court of Claims, the Appellate Court held in its original opinion in this case that the use of the statutory apportionment formula did not accurately reflect income attributed to Michigan and therefore the taxpayer was entitled to use alternative apportionment. The court did not directly address any of the other arguments presented by the taxpayer. Upon review, the Michigan Supreme Court remanded, holding that the Appellate Court first needed to address how the proceeds should be treated under the statutory apportionment method (i.e., single sales factor) before addressing whether an alternative method should be applied.

The Appellate Court then remanded the case back to the Court of Claims to address “whether the sale of the business should have been included in the sales factor.” Last month, the Court of Claims concluded that the statutory definition of “sale” does not contemplate the sale of an entire business and thus the proceeds were properly excluded from the sales factor under the statutory formula.  In reaching its conclusion, the Court of Claims rejected the taxpayer’s position that what is included in the tax base must be included in the sales factor. The case was then appealed back up to the Appellate Court. The Court of Appeals affirmed the Court of Claims decision, and readopted the reasoning employed in its 2020 decision that application of the statutory formula in this instance resulted in a constitutional violation and an alternative formula must be applied. The Appellate Court remanded the case back to the Court of Claims to determine the proper alternate apportionment method to apply. Please contact Dan De Jong with questions on the decision in Vectren v. Department of Treasury. 

This Week's Developments

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Sarah McGahan

Sarah McGahan

Managing Director, State & Local Tax, KPMG US