I.  Introduction

Michigan is a great location for Israeli businesses to locate.  Michigan has a large number of highly trained engineers and technical employees and close proximity to the automotive manufacturers and suppliers.  We also have a strong presence in other fields including computer science, military, alternative energy and chemical development.  This article is a summary of the various types of taxes to be encountered by inbound companies and individuals and does not cover every situation.  The specific facts of each company or individual should be reviewed by a qualified tax professional.

II.  Federal Taxation

Personal Income Tax

Federal taxation of income of foreign individual investors will depend on a host of factors, including the nature and extent of the individual's activities within the U.S. Investment income can be treated either as ordinary income or capital income.

All U.S. tax residents (whether citizens or aliens) are subject to U.S. income tax on their worldwide net income, at rates ranging from 10% to 35%. The test for a tax resident is different than other residency requirements and is different than the domicile test. Recent tax reform on the federal level will cause these rates to fluctuate in different calendar years. Nonresident aliens are subject to tax on only their income derived from U.S. sources. Passive income of nonresidents, not effectively connected with a U.S. trade or business, is taxed at a flat 30%, or lower if treaty provisions apply between the investor's country of residence and the U.S. The progressive rates (where applicable) are based on net income (gross income reduced by certain deductions), whereas the 30% rate (or lower rate if a treaty so provides) is based on gross income.

Determining whether income is effectively connected with a U.S. trade or business is critical to measuring its exposure to U.S. income tax. Generally such income will be so treated as US source if it is derived from a permanent establishment in the U.S., such as a store, office, or factory.  However, the activities of even one person, if they are extensive enough could create a permanent establishment.

Gain upon sale of U.S. real property will be taxable to a foreign individual as effectively connected income.

Corporate Income Tax

"C" Corporations (all corporations not qualifying as "S" Corporations, as explained below).

The U.S. treats corporations not organized under the laws of the U.S. or one of its 50 states as foreign entities. As such a foreign corporation is treated similarly to an individual who is a nonresident alien. The net income of a foreign corporation that relates to its U.S. activity is taxed at rates ranging from 15% to 35% depending upon the amount of income, the same as for a U.S. domiciled corporation. Its passive income, however, is taxed at 30% of gross income (or a lower rate if a treaty relief provision applies).

Repatriation of the income to the foreign owner of a U.S. business presents an additional obstacle. If the U.S. business is operated as a branch of the foreign corporation, its income (as reduced by the tax imposed on its net income) is again subject to a branch profits tax of 30% of the gross amount deemed to be remitted overseas. This second level tax operates to equate the total tax that would apply if the business were a subsidiary of the foreign corporation rather than a branch. If the foreign corporation (in case of a U.S. branch) is a "qualified resident" of a country with which the United States has an income tax treaty, and such treaty contains a valid nondiscrimination clause, the branch tax can be avoided. The U.S. has tax treaties with nearly every industrialized country and with many developing countries; such treaties include: Aruba, Austria, Belgium, Cyprus, Denmark, Egypt, Finland, Germany, Greece, Hungary, Iceland, India, Ireland, Israel, Italy, Jamaica, Japan, Korea, Luxembourg, Malta, Morocco, Netherlands, Netherlands Antilles, Norway, Pakistan, People's Republic of China, Philippines, Sweden, Switzerland, and the United Kingdom.

Unfortunately, the certification as a "qualified resident" is not easily obtained by a private company. Generally, therefore, it is often more prudent to operate with a U.S. subsidiary than a U.S. branch.

If a U.S. subsidiary is used, any tax on repatriated income will be deferred until a dividend is actually paid. A second advantage of using a subsidiary is the possibility of using lower withholding rates that are available to parent corporations in treaty countries since such dividends will be treated as passive income. Subject to the "earnings stripping" limitations recently enacted by the U.S., the subsidiary may obtain a U.S. income tax deduction for interest it remits to its parent, whereas dividends are not deductible.

Foreign investors should be cautioned that any intercompany transactions between a U.S. subsidiary and its foreign parent should involve arm's length prices and other terms. If the U.S. tax authorities find that U.S. taxable income has been artificially depressed by unfair pricing, they can reallocate income and expense between the parties. This would create not only additional U.S. income tax, but substantial penalties as well.

"S" Corporations

Certain U.S. corporations are eligible to elect to avoid U.S. income tax at the corporate level by making an election under Subchapter S of the Internal Revenue Code. Instead of the income being taxed at the corporate level the income is taxed to the shareholders, pro rata, whether or not actually distributed. The use of "S" Corporations is restrictive, certain individuals and entities may not be able to use this device because they are not eligible S Corporation shareholders. Recent changes to the Internal Revenue Code have relaxed some of the prior restrictions on S Corporation shareholders but the provisions are still restrictive. One such restriction is that an "S" Corporation cannot have more than 75 shareholders.

Income Taxation of Partnerships and Limited Liability Companies

A partnership entity is not a separate person for Federal income tax purposes. As such, the net income of the partnership is allocated and taxed directly to the partners, whether or not cash is actually distributed to them. This avoids the "double taxation" that can plague a corporation's earnings i.e., a corporation (other than an S corporation) must pay tax on its earnings and then its shareholders must pay personal tax on any dividends or other distributions received by them from the corporation. A partnership's earnings are taxed only once, to its partners. However, since the partners will pay tax whether or not the partner's earnings are distributed, partners may have a tax liability even when they have received no distributions with which to pay the tax. In short, the allocation of profit is taxable; the distribution of profit to partners is not.

The flow-through nature of partnership taxation also means that partnership losses can be deducted by partners against their personal income from other sources. A number of limitations may limit this availability, however, including rules regarding basis and passive losses.

A limited liability company will be taxed in the same manner as a partnership unless it elects otherwise; that is, the LLC will pay no taxes at the entity level, and the members will be taxed on their allocated share of company earnings and will be allowed to deduct their allocated share of company losses.

Although a partnership or LLC pays no entity-level Federal income tax, it is responsible for withholding of payroll taxes from its employees and payment of the employer portion of social security taxes as well as state and Federal unemployment taxes.

Partnerships and LLCs in Michigan, like other business entities, are subject to Michigan Business Tax, discussed below.

Estate and Gift Taxation of U.S. Citizens

Federal law imposes an integrated gift and estate tax on certain transfers made by U.S. citizens. The law in this area changes often. Currently, any individual U.S. citizen may make up to $1,000,000 in lifetime gifts and/or may transfer up to $2,000,000 upon death in 2008. The Applicable Exclusion Amount, the amount of wealth that potentially can be transferred at death without federal estate tax, is changing nearly every year under current policy. The Applicable Exclusion Amounts for the previous, current and future years based on current law (September, 2008) are as follows:

It is estimated that due to Federal budget concerns, the Applicable Exclusion Amount will be changed prior to the end of 2009. In addition, federal law permits individuals to make additional annual gifts of cash or cash equivalents of up to $12,000 per beneficiary without using up any portion of their exemptions. Taxable transfers in excess of $1,000,000 are subject to a graduated tax ranging from 39 to 45 percent. Special rules apply to taxable estates valued at $3,000,000 or more.

No tax is imposed on the transfer of assets from one U.S. citizen spouse to another U.S. citizen spouse. However, a gift tax is imposed on transfers by a U.S. citizen to a non-citizen spouse in excess of $100,000 annually. Through proper estate planning, a married couple may shelter up to $3,000,000 from gift and estate taxation by using a Qualified Domestic Trust and irrevocable trusts also may be used to leverage even greater estate tax savings.

A related federal transfer tax is the "generation skipping" transfer tax, which is designed to prevent taxpayers from making transfers of substantial assets to grandchildren and lower generation family members so as to avoid taxation of such assets in the estates of the taxpayers' children. Generation-skipping transfers in excess of $2,000,000 are subject to the generation-skipping transfer tax at a flat rate of 55 percent. Beginning in 2004, the exemption amount was linked to the Applicable Exemption amount.

Estate Taxation of Foreign Individuals

The death of a foreign individual may have U.S. federal estate tax implications. As in the case of federal income taxation of foreign individuals, two different classifications apply to the estate taxation of foreign individuals, depending on whether the foreign individual at the time of death is a "resident alien" or a "nonresident alien."

Determination of Residency Status. The tests for determining residency status for federal estate tax purposes and for federal income tax purposes are different. For estate tax purposes the crucial inquiry is the foreign individual's "domicile" at the time of death. A resident alien for estate tax purposes is one domiciled in the United States at the time of death. A non-resident alien is one not domiciled in the United States at the time of death.

A person who enters the United States with an immigrant visa (a "green card") is considered to be U.S.-domiciled until he or she leaves the United States with no intention of returning. For other individuals the determination of domicile depends upon various factors, including the length and permanence of the individual's stay in the United States and the individual's ties with the individual's home country. An individual may be classified as a resident alien for income tax purposes because he or she was in the United States for at least 183 days per year, yet as a nonresident alien for estate tax purposes because of an intention to return to the country of citizenship.

Estate Taxation of Resident Aliens. The estate of a resident alien is generally taxed in the same manner as the estate of a United States citizen. The taxable estate of a resident alien generally includes all property owned worldwide. Special rules reduce the taxable estate when the decedent makes bequests to, or on behalf of, a surviving spouse. If the resident alien's spouse is not a United States citizen, the bequests must be made to a special trust on behalf of the surviving spouse in order to qualify for this treatment. One of the requirements of the special trust is that the trustee must be either a United States citizen or a United States corporation.

The first $2,000,000 of the resident alien's taxable estate which remains after reduction for bequests to a surviving spouse, is exempt from estate taxation. The remainder of the estate is taxed at graduated rates of 39 to 45 percent.

Estate Taxation of Nonresident Aliens. The estate of a nonresident alien includes only property that on date of death is "situated" in the United States. Among items which are considered situated in the United States are United States real property, tangible property located in the United States and shares of stock in United States corporations. Shares of stock in a foreign corporation held by a nonresident alien are not subject to the United States estate tax. Nonresidents making investments in the United States through foreign corporations may avoid United States estate taxes by such investments.

The rules governing bequests to a surviving spouse apply both to resident and nonresident aliens. Of the balance of the nonresident alien's estate remaining after bequests to a surviving spouse, the first $100,000 (as contrasted with $1,500,000 in the case of a resident alien) is exempt from estate taxation. The balance is taxed at graduated rates of 26 to 49 percent. Special rules apply to any taxable estate of $10,000,000 or more.

Impact of Tax Treaties. The United States has entered into estate tax treaties with certain countries. Typically, such treaties set forth special "tiebreaker" rules which determine the estate tax status of a foreign individual who might otherwise be found to be domiciled in more than one country. Such treaties often provide for an increase of the $100,000 exemption applicable to the estate of a nonresident alien.

Gift Taxation

Gifts made by foreign individuals may be subject to United States gift taxation. Resident aliens are taxed on gifts made worldwide. Nonresident aliens are taxed on gifts only if the gift property is situated in the United States. For federal gift tax purposes "resident alien" and "nonresident alien" are defined as they are defined for federal estate tax purposes.

Certain gifts may be made without the imposition of tax. As of 2008, gifts of up to $12,000 per year can be made to each donee without any gift tax liability. Gifts of up to $100,000 can be made each year to a spouse by a resident alien or nonresident alien without gift tax liability if the spouse is not a United States citizen.

The United States has entered into gift treaties with some countries. Under these treaties special gift tax rules apply.

III.  Michigan Taxation

Personal Income

The Michigan income tax is imposed on residents as to virtually all income. It applies to nonresidents only to the extent such income is earned in Michigan. A person who is resident in Michigan for at least 183 days of the taxable year is presumed to be a resident.

The tax base for the Michigan income tax is the federal income tax base, with certain modifications not likely to concern a foreign individual. The tax rate for 2008 is a flat 3.9% of taxable income. The Michigan income tax is deductible in computing the individual's federal taxable income if the individual itemizes their deductions.

Business Taxes in Michigan

Effective January 1, 2008, Michigan has enacted the Michigan Business Tax (“MBT”) to replace the much maligned Single Business Tax (“SBT”).  The MBT applies to business activity that has a substantial nexus with the State of Michigan.  A business that conducts business in multiple states must apportion income derived from its Michigan activities pursuant to a formula.

Michigan offers major tax abatements for eligible businesses that create large numbers of well-paying new jobs. In addition, the state has more than 100 tax-free Renaissance Zones to spur investment and job creation. Michigan also offers several state affiliated venture capital funds to encourage early stage interests in certain types of technology and energy businesses. Michigan also instituted a 100% personal property tax exemption for investments in qualified areas.  Michigan offers tax credits to the production of  films in Michigan.  Overall, Michigan's tax burden is now below the national average.

Michigan's key state taxes are:

•    Business Tax (MBT) beginning January 1, 2008.

•    Property Taxes.

•    Sales and Use Taxes.

The new Michigan Business Tax effective January 1, 2008, (MBT) was heralded to create new jobs and reduce business taxes upon approximately 70% to 75% of businesses in Michigan.  The new MBT:

•    Features both a business income tax and a Modified Gross Receipts tax, the rate of tax on business income is  4.95% and the rate of tax on gross receipts (minus purchases from other companies including inventory and capital expenditures) is .8% (less than 1%).  A business can be charged with both taxes;

•    Creates new tax credits for “Compensation and Investment,” “Research and Development,” “Personal Property Tax Credits,” “Entrepreneurial Credits,” and other Special Sector Credits;

•    Retains prior tax credits such as Investment Tax Credit, Startup Credit, Early Stage Venture Credit, MEGA Credits, Renaissance Zone Credits, Historic Preservation Credits, Brownfield Credit, Workers Disability Credit, Public Contribution Credit, and certain charitable credits; and

•    Contains provisions for alternate tax on qualifying small businesses with receipts below $18,000,000.

Property Taxes

Michigan significantly reduced the state's property tax burden. Reforms instituted in 1994 have reduced the state's reliance on property taxes to fund schools.

•    Major reforms have resulted in lowering property tax rates for businesses in excess of 10%.

•    Michigan's per capita property tax burden is now below the national average.

•    Michigan's property tax is assessed at the state and local levels, and can be abated at the local and state levels.

•    Taxable value of property is 50% of current market value, including both real and personal property.

•    Annual property assessment increases are limited to the lesser of 5% or the rate of inflation.

For businesses, property tax exemptions are available for:

•    special tools, dies, jigs, and patterns in manufacturing.

•    electricity and natural gas used in production.

•    air and water pollution control abatement equipment.

Workers Compensation

Significant reforms in Michigan's workers' compensation system have resulted in lowered costs and increased efficiency. Under the reforms:

•    An open competitive system allows employers to "shop around" for the least expensive

insurance carrier.

•    Eligible businesses can self-insure or join self-insurance pools allowing some companies to

save as much as 50%.

•    In each of the last five years, workers' compensation insurance rates have declined.

Sales Tax

Michigan has a 6% state sales tax and allows no local sales tax. Many industrial and consumer goods and transactions are exempt from Michigan sales taxes: food, prescription drugs, medical devices, newspapers and periodicals, water, and commercial vessels. Also, exempt sales for resale, property in interstate or foreign commerce, computers used in industrial processing, custom computer software, information services, railroad rolling stock, air and water pollution control facilities, and energy fuels. Machinery and materials used directly in a manufacturing process are also exempt.

Personal Income Taxes

Michigan has a flat rate personal income tax of 4.01% effective January 1, 2008.

Tax-Cuts

Over the last several years, Michigan has enacted over 30 different tax cuts and has created additional incentives for business to locate, expand, and grow in Michigan.

Highlights of Michigan's tax cuts:

•    Single Business Tax (SBT) – Eliminated as of December 31, 2007 and  replaced by Michigan Business Tax beginning January 1, 2008

•   Personal Income Tax

o    Extended child deduction ($600 per child).

o    Personal exemption increased to $3,400, and indexed to the rate of inflation.

o    Virtual elimination of state income tax on private pensions; senior citizen deduction of up to $8,408 for earned interest, dividends, and capital gains.

•   Property Tax

o    Constitutional limit on property tax collections, (the Headlee amendment), under which a mandatory rollback refunded $113 million to taxpayers in 1995. Also, homestead property tax credits are available for primary residents.

•    Tax-Free Zones

o    Most state and local taxes eliminated in more than 100 designated Renaissance Zones statewide to spur creation of new jobs and investment.

•   Additional Tax Reforms

o    Prior Inheritance tax repealed and Michigan Estate Tax was also phased out in 2005 due to inactivity by Legislature.

o    Intangibles tax eliminated.

o    Brownfield Rehabilitation Credit exists and encouraged to clean up    contaminated properties and make productive.

Estate Taxation Of Individuals

The Michigan Inheritance Tax was eliminated in 1993 and a new Michigan Estate Tax was enacted as a “pick up” tax to the Federal Estate Tax.  Due to changes in the Federal Estate Tax in 2004, the State Estate Tax Credit was phased out and as a result, the State of Michigan Estate Tax was rendered a nullity.  Despite the passage of several years, no new estate or inheritance tax has passed.  Since 2005, more than ten other states have established a new inheritance tax but Michigan has not done so.

Jeffrey D. Moss is a tax attorney in the Bloomfield Hills office of Butzel Long, PC.  Butzel Long has offices throughout Michigan and also has offices in New York and Washington D.C.  You can learn more about Jeff and Butzel Long by going to www.butzel.com.

This Article is not an opinion for tax purposes and cannot be used or relied upon pursuant to IRS Circular 230 for the purposes of avoiding penalties.