Volume XXII, Issue 1 First Quarter 1996

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TABLE OF CONTENTS

CHAIRPERSON'S LETTER TO TAXATION SECTION MEMBERS 2

REPORTS FROM THE COMMITTEES Corporation Committee 5 Employee Benefits Committee 6 Estates & Trusts Committee 6 International Tax Law Committee 7 Partnership Committee 8 Practice & Procedure Committee 8 State & Local Committee 10 FEATURE ARTICLES The Implied Covenant Not To Compete- An IRS Red Herring? By: Robert L. Cohen & Robert A. Bryant 12 General Considerations of Nonqualified Deferred Compensation Arrangements By: Bryan I. Pukoff 19 STATE AND LOCAL TAX UPDATE Recent Cases 26 SHORT SUBJECTS Book Review 29 Shortcuts 30 SECTION NEWS Calendar of Seminars & Events 32 MICHIGAN TAX LAWYER

The Michigan Tax Lawyer is a quarterly publication of the Taxation Section of the State Bar of Michigan that is designed to be a practical and useful resource for the tax practitioner. Features include concise reports in a uniform format from the Section's committees, practitioner articles with the "how to" approach, news of events and of other Section members, and "Short Subjects" providing helpful practice information. Input from members of the Taxation Section is most welcome. Our publication is aimed toward involving you in Section activities and assisting you in your practice. If you have suggestions or an article you wish to have considered for publication, please contact Joseph A Bonventre, Esq. at 1600 First Federal Building, Detroit, Michigan 48226-1962, (313) 965-8300. JOSEPH A. BONVENTRE Editor Publication Committee ERIC T. WEISS WILLIAM E. SIDER State Bar of Michigan Taxation Section Council CAROL J. KARR STEPHEN M. FELDMAN GEORGE W. GREGORY Chairperson Vice Chairperson Secretary-Treasurer REGINALD J. NIZOL Ex-Officio Joseph A. Bonventre Mark C. Larson James H. N ovis William E. Sider Stewart L. Mandell Eric T. Weiss Gary Schwarcz Thomas G. Mies Robert R. Stead Editor's Assistant Mary G. Trayner Subscription Information The Michigan Tax Lawyer (ISSN 0899-2460), (USPS 093930) is published quarterly by the Taxation Section, State Bar of Michigan, 525 North Woodward, Suite 1300, Bloomfield Hills, Michigan 48304-2969. Subscription fee of $5.00 is included in the $30.00 annual Taxation Section membership fee. Second-class postage paid at Bloomfield Hills, Michigan. POSTMAS­ TER: Send address changes to Membership Records, Taxation Section, State Bar of Michigan, 306 Townsend, Lansing, Michigan 48904. Change of Address Individual subscribers should send notification in writing to: Membership Records, Taxation Section, State Bar of Michigan, 306 Townsend, Lansing, Michigan 48904. Citation Form The Michigan Tax Lawyer may be cited as follows: (Vol.) (Issue) MI Tax L. (Page) (Qtr. and Yr.). Disclaimer The opinions expressed herein are those of the authors exclusively and do not necessarily reflect those of the Publication Committee, the Taxation Section Council or the Taxation Section. It is the responsibility of the individual lawyer to determine if advice or comments in an article are appropriate or relevant in a given situation. The Publication Committee, the Taxation Section Council and the Taxation Section disclaim all liability resulting from statements and opinions contained in the Michigan Tax Lawyer. CHAIRPERSON CAROL J. KARR 800 CALDER PLAZA BLDG. GRAND RAPIDS 49503·2250 (616) 459-8311 TAXATION SECTION VICE-CHAIRPERSON STEPHEN M. FELDMAN SUITE 200 32300 NORTHWESTERN HWY. STATE MICHIGAN FARMINGTON HILLS 48334-1567 c (810) 855-6500

SECRETARY-TREASURER GEORGE W. GREGORY 300 WABEEK BLDG. 280 W. MAPLE RD. BIRMINGHAM 48009-3344 (810) 646-4200

COUNCIL February 7, 1996 JOSEPH A. BONVENTRE (313) 965-8293

MARK C. LARSON (313) 568-6790

STEWART L. MANDELL (313) 568-6796

THOMAS G. MIES Dear Taxation Section Members: (313) 421-8022

JAMES H. NOVIS (313) 256-7940 The Taxation Section is reaching out with ... GARY SCHWARCZ (810) 855-8808

WILLIAM E. SIDER (313) 961-8380 National speakers at the Summer Tax Conference. Register for ROBERT R. STEAD Friday and Saturday, June 14 and 15, 1996, at the Grand Traverse Resort for an (616) 949-2300

ERIC T. WEISS enjoyable way to broaden your knowledge. Out-of-state speakers include: Alan (810) 355-5000 M. Ellenby, Senior Manager at Ernst & Young in Chicago; Judge David Laro of EX-OFFICIO the U.S. Tax Court in Washington, D.C.; Andrew Katzenstein with Manatt, Phelps REGINALD J. NIZOL (313) 225-2676 & Phillips in Los Angeles; and C. Clinton Stretch, Director of Tax Legislative COMMISSIONER LIAISON Affairs for Deloitte & Touche in Washington, D.C. Also hear what is happening PAUL R. SOWERBY (810) 851-1200 in Lansing from David Kirvan, Administrator, Single Business Tax, and Paul ( COMMITIEE CHAIRPERSONS Hillegonds, Speaker of the House ofRepresentatives. CORPORATION KENNETH W. KINGMA (810) 528-1111 Liaisons with other State Bar Sections. As an outgrowth of EMPLOYEE BENEFITS SHERILL A. SIEBERT discussion between the Taxation Council and Probate Council regarding the (313) 256-7502 proposed Estate Settlement Act, Robin Ferriby from the Probate Council has ESTATES AND TRUSTS EDWARD M. DERON (313) 963-9625 volunteered to attend Taxation Council meetings to keep us apprised of Probate INTERNATIONAL Council activities. The Administrative Law Section has invited the Taxation EDWARD D. MacDONALD (313) 956-2677 Council to select a representative to their Council and Gary Schwarcz has agreed PARTNERSHIP ANTHONY ILARDI, JR. to serve in that capacity. We are also exploring the possibility of a liaison with the (810) 362-8212 Business Law Section. PRACTICE AND PROCEDURE ERIC M. NEMETH (810) 357-3010

STATE AND LOCAL A legislative liaison to the Michigan Legislature. For the first GREGORY A. NOWAK (313) 259-0500 time this year, we have appointed an official legislative liaison to the Michigan PROGRAM FACILITAlOR that KAREN A. NIZOL legislature and Jim Novis is working in capacity to encourage communication. 16411 NOLA DR. LIVONIA 48154-1206 Legislative representatives will also be invited to meet with Taxation Council (313) 953-0088 members before the May Council meeting in Lansing.

A Computer Committee to explore communication through the Internet. The State Bar is preparing to establish a virtual private network on the Internet. Steve Feldman, George Gregory, and Tony llardi have agreed to (

PAST COUNCIL CHAIRPERSONS ALLAN J. CLAYPOOL OSCAR H. FELDMAN JOHN L. KING JACK E. MITCHELL B. COURTNEY RANKIN JOHN N. SEAMAN STEPHEN H. CLINK EUGENE A. GARGARO, JR. DONALD M. LANSKY DENNIS M. MITZEL JOHN J. RAYMOND, SR. PETER S. SHELDON JOHN J. COLLINS, JR. ERNEST GETZ JEFFREY A. LEVINE J. LEE MURPHY DAVID M. ROSENBERGER WILLIAM J. SIKKENGA ROGER COOK JOSEPH D. HARTWIG ARNOLD W. WNGERSHAUSEN LAWRENCE J. MURPHY ANDREW M. SAVEL I. JOHN SNIDER, II CLIFFORD H. DOMKE STEPHEN I. JURMU JERRY D. WPTAK ROBERT B. PIERCE BENJAMIN 0. SCHWENDENER. JR. LAWRFNr.F R VAN Til investigate how the Taxation Section can b~st utilize Internet access to facilitate communication among Section members.

Participation in the National Association of State Bar Taxation Sections. Our Vice-Chairperson, Steve Feldman, represented our Taxation Section at the 16th Annual Meeting of the National Association of State Bar Taxation Sections in October. Once again, our Michigan. Tax Lawyer and Taxation Section Membership Directory were applauded as model publications and Steve learned what other Taxation Sections across the country are accomplishing.

As we are reaching out, are we reaching you? Let us know what else we can do to maximize your Taxation Section membership.

Sincerely,

Carol J. Karr, Chairperson Reports from the Michigan Tax Lawyer-1st Quarter 1996 Committees

Report of the 453 is not available in a 338(h)(10) Corporation Committee transaction. Kenneth M. Kingma, Chairperson 2. Article Regarding Purchase Kemp, Klein, Umphrey & Endelman, P.C. Price Allocations Involving Suite 600 Columbia Center Noncompete Agreements. The 201 West Big Beaver Road second part of a two-part article P.O. Box 4300 written by Robert L. Cohen concern­ Troy, Michigan 48099-4300 ing purchase price allocations (810) 528-1111 involving noncompete agreements is published in this issue of the 1. Recent Activities. Michigan Tax Lawyer. The portion On November 30, 1995, the Corpo­ printed in this issue discusses the ration Committee conducted a joint various shortcomings of the IRS meeting with the Partnership Com­ implied covenant theory that is based mittee regarding Section 338(h)(10) on Colten v Duvall, 254 Mich 346 elections, which are frequently made (1931), and also discusses two federal in merger and acquisition transac­ tax decisions rejecting that theory. tions today. Robert L. Cohen of Plante & Moran, LLP led the discus­ 3. Clinton Administration sion on this topic. Robert provided Proposal To Repeal The Built-In informative handouts (including a Gains Rules For Large C-To-S recent article he wrote) regarding the Corporation Conversions. Among basics of a 338(h)(10) election follow­ the Clinton administration proposals ing the enactment of recent regula­ to achieve a balanced budget is a tions that expanded its use to acqui­ proposal to repeal the built-in gains sitions of S corporation stock. He rules under Section 1374 for large C also discussed the election's applica­ corporations that elect S corporation tion to sales of stock of a subsidiary status after December 6, 1995. A in a consolidated group. During his notice regarding this proposal was discussion; Robert went through a mailed to members of the Corpora­ handout containing an example that tion Committee and the Tax Section. showed the results of a stock pur­ On February 22, 1996, the Treasury chase involving no 338 election, a Department announced that it will 338(g) election, a 338(h)(10) election, recommend to Congress that the and a straight asset sale by a sole proposed repeal apply only to S corporate shareholder or a sole corporation elections effective for individual shareholder. Copies of taxable years beginning after Janu­ these handouts are available upon ary 1, 1997. A notice regarding this request. announcement was also mailed to At the end of the meeting, Ken members of the Corporation Commit­ Kingma spoke on the ability to elect tee and to other members of the Tax installment sale treatment in a Section. That notice discussed, 388(h)(10) transaction and on ac­ among other things, certain dead­ counting issues for an installment lines for electing or terminating an S sale with a contingent purchase election based on the proposed repeal price. Also discussed were recent and the Treasury announcement. As articles and telephone discussions of March 7, 1996 (when this report with the IRS on these matters. The was last revised), the proposed repeal IRS has advised during informal was still active and was included in telephone discussions that install­ the latest budget numbers issued by ment sale treatment under Section the Clinton administration. Tax 5 Reports from the Committees Michigan Tax Lawyer-1st Quarter 1996

Section members should contact Ken Report of Estates Kingma if they would like to have the Corporation Committee or the Tax and Trusts Committee Section respond to this proposal or to Edward M. Deron, Chairperson any other corporate tax proposal Evans & Luptak, P.L.C. before Congress. 2500 Buhl Building Detroit, Michigan 48226 (313) 596-0626 Report of the Employee 1. Chairperson's Message. Benefits Committee With all the talk about simplifying Sherill Siebert, Chairperson the federal income tax, it is interest­ Honigman Miller Schwartz and Cohn ing to note that Representative Cox 2290 First National Building of California and Senator Kyl of Detroit, Michigan 48226 Arizona propose a total elimination (313) 256-7502 of the federal estate and gift tax. · Any bets on where that will end up? 1. Recent Activities. Robin D. Ferriby, Chair of the Our last meeting was held January Estate Settlement Act Legislative 23, 1996, at the Sheraton Oaks Hotel Enactment Group, has agreed to in N ovi. Approximately 30 Commit­ serve as the Probate and Estate tee members heard Kenneth J. Kies, Planning Section Liaison to the Chief of Staff of the Joint Committee Taxation Section. We look forward of Taxation, and his colleague, to Robin's updates on the status of Brian Graff, discuss the status of the proposed Estate Settlement Act ( the budget bill and, in particular, the and on working with him on matters employee benefits provisions which of mutual interest to both Sections. may be included in it. Discussion Do you have a meeting pre­ included details of the pension sim­ sentation topic and/or speaker plification proposals, comparison of that interests you? Do you have budget bill and administration pro­ some information that you would posals, and possible effective dates. be interested in sharing with com­ Mr. Kies also provided an overview mittee members by way of a meeting of the current tax reform proposals. presentation, article or otherwise? If so, please contact me. 2. Future Schedule. Our next Committee meeting will 2. Recent Activities. take place on May 9, 1996 at the Novi On February 1, 1996, Michael H. Hilton. We will have a representa­ Obloy, Vice President and Senior tive from the Department of Labor on Trust Counsel of Comerica Bank, hand to discuss the newly proposed made a presentation to our Commit­ plan asset regulations, proposed tee on the topic of "Recent Develop­ participant education guidelines, and ments in Estate and Trust Taxation". other recent Department of Labor Mike's comments included an over­ activities. Watch your mail for the view of proposed and potential meeting notice. federal tax legislation and touched on a number of important federal developments.

3. Future Schedule. The next meeting of our Committee is still in the preliminary planning 6 stages. Watch your mail and future ---- Reports from the Michigan Tax Lawyer-1st Quarter 1996 Committees

issues of the Michigan Tax Lawyer Report of the for notices of that and other future meetings. International Tax It's time to make your plans for Law Committee this year's Summer Tax Conference which is being held at the Grand Edward D. MacDonald, Chairperson Traverse Resort in Acme, Michigan Chrysler Corporation on Friday, June 14th and Saturday, 12000 Chrysler Drive, 416-16-05 Highland Park, Michigan 48288 June 15, 1996. The topics and speak­ (313) 956-2877 ers include among others ''Business Valuation: Fair Market Value, Lack 1. Chairperson's Message. of Marketability Discount, Use of Our next meeting is tentatively sched­ Expert Testimony, and Recent Tax uled to take place in July. If anyone Court Cases" presented by U.S. Tax has ~ny issues they would like to see Court Judge, David Laro and "A addressed, please contact me with Thinking Man's Perspective on your suggestions. Current Estate Planning Strategies and Recent Developments" by An­ 2. Recent Developments. drew Katzenstein. There will be Notice 96-12 an optional barbecue for conferen~e On February 20, 1996 the IRS issued participants and their guests.dun~g notice 96-12 to provide guidance on the evening of June 14th, whiCh will whether taxpayers' transactions with be preceded by a complimentary related persons, including members welcome reception. Grand Traverse of the consolidated group, may be Resort is a great family destination, transactions with customers for featuring a variety of activities; purposes of § 475. including golf, indoor tennis and This is a draconian measure since racquetball courts, swimming pool many taxpayers find it convenient and and saunas. Contact me if you need cost effective to enter into cross-border a brochure. intercompany derivative transaction activities. Now these types of transac­ 4. Important Developments. tions may cause taxpayers to be The final Generation Skipping Trans­ treated as a dealer in securities and, fer Tax Regulations have been issued therefore, all securities (e.g., portfolio with an effective date of December investments) held by them would be 27, 1995. They contain guidance subject to the mark-to-market require­ on the allocation of the Generation ments of§ 4 75(a) unless they were Skipping Tax exemption, estate tax identified on the day acquired as inclusion period, determination of qualifying for one of the§ 475(b) the applicable fractions, division of exceptions from the mark-to-market a single trust into separate trusts, rules. It should be noted that securi­ application of the tax to non-resident ties are broadly defined by § 4 7 5 to aliens and transitional rules. include a wide range of financial The final income, estate, and gift instruments. tax regulations adopting, with minor This rule is expected to be effective clarifications, the proposed excep­ for taxable years beginning on or after tions to using standard valuation February 20, 1996. tables for valuing annuities, interests Taxpayers may have to consider for life or a term of years, and isolating these transactions in a new remainder or reversionary interests dealer subsidiary so that these inter­ under Section 7520 have been company transactions do not adversely issued effective for transactions affect its other security holdings. after December 13, 1995. 7 ~~----- Reports from the Committees Michigan Tax Lawyer-1st Quarter 1996

Report of the viewed as an entity, reasoning that since partnerships were not Partnership Committee controlled foreign corporations, Anthony Ilardi, Chairperson they the partners did not have Mager, Mercer, Scott & Alber, P.C. subpart F income. The full Tax 755 West Big Beaver Rd., Ste. 1700 Court, on the IRS' motion to Troy, Michigan 48084 (81 0) 362-8212 reconsider, concluded that the partnership should be viewed 1. Recent Activities. as an aggregate. Therefore, the On November 30, 1995, the Partner- income received by the partner- ship Committee held a joint meeting ship when allocated to the CFC with the Corporations Committee at partner would retain its subpart the offices of Kemp, Klein, Umphrey F income characterization. & Endelman. Robe:rt Cohen, of The Brown Group case led, Plante & Moran, concluded his in part, to adoption of the Anti- presentation and led a discussion on Abuse Regulations (Treas. Reg. Purchase Price Allocations and IRC § 1.701-2). The Eighth Circuit § 338(h)(10). concluded that the partnership would be treated as an entity, in 2. Recent Developments. part because under the pre-1987 a. Regulations. subpart F rules the partnership On December 29, 1995, the IRS was not a "related person." The issued final regulations. under Court declined to apply the Anti- IRC § 737, (relating to distribu- Abuse Regulations, concluding tions of property to a partner they were not retroactive. The (. who contributed property to the Court did not reach the issue '~. partnership), and final regula- of the validity of the anti-abuse tions under IRC § 704(c)(1)m) regulations, an issue that is (relating to the recognition of likely to arise in the future. gain by the contributing partner on a distribution of built-in gain 3. Future Schedule. property to another partner). The next Committee meeting will be T.D. 8642. held on February 22, 1996 at 3:30 The IRS also issued proposed P.M. at the offices of Kemp, Klein, regulations under IRC § 731(c). Umphrey & Endelman. Tony Ilardi This provision was added to the will make a presentation and lead a Code by the 1994 GATT amend- discussion on the final Section 737 ments. Section 731(c) treats Regulations and the Proposed Section certain distributions of market- 731(c) Regulations. able securities (other than distri- butions by "investment Report of the Practice partnerships") as distributions of money. and Procedure b. Cases. Committee On January 25, 1996, the Eighth Circuit reversed the Tax Court in Eric M. Nemeth, Chairperson Brown Group, Inc. In this case, Raymond & Prokop, P.C. the issue was whether a con- 2000 Town Center, Suite 2400 trolled partnership had subpart Southfield, Michigan 48075 F income (under pre-1987 law). The Tax Court originally held 1. Chairperson's Message. that the partnership should be By the time this issue goes to press, c 8 we will already have had our annual Reports from the Michigan Tax Lawyer-1st Quarter 1996 Committees

I.R.S.-State Bar Liaison Meeting Commissioner, 1995 Fed App. 0379P, which was scheduled for February that the common law mail box rule, 21, 1996 at the Holiday Inn Crowne that proof of mailing a properly Plaza. I am very gratified at the addressed communication with the projected turnout. It appears that appropriate postage raises a rebut­ our attendance numbers will be up table presumption of receipt in due significantly from past years. What course by the addressee does not is particularly good to see is partici­ apply to the IRS. A taxpayer in the pation from government attorneys, Sixth Circuit "who sends a document sole-practitioners, small and medium to the IRS by regular mail, as op­ firms as well as the largest firms. posed to registered or certified mail, A complete report of the meeting does so at his peril" according to the will be featured in my next report. Court. The moral of the story is clear I have recently been inVited to in that if you want an insurance attend the IRS Northeast Region/Bar policy against a delinquency penalty Liaison Meeting in New York City or failure to pay penalty, send the on March 21 and 22 as the State Bar document certified or registered. I Representative. With the recent IRS would be cautious though that if the and Chief Counsel reorganization, document at issue is lost by the IRS, we in Michigan are now in the you still may have a battle to fight Northeast region instead of the now because registered or certified mail­ defunct Central region which as you ing only creates a presumption of know was in Cincinnati, Ohio. If I timely mailing and is not conclusive. am able to attend, look to this column In a somewhat unheralded opinion for a full report. by the Supreme Court this past summer in United States v. Gaudin, 2. Future Activities 115 S.Ct. 2310 (1995), a unanimous I am pleased to announce that our court held that the issue of material­ next Committee meeting will be held ity of an alleged false statement in on April 9, 1996 at 3:30 p.m. at the violation of 18 U.S.C. §1001 is a offices of Raymond & Prokop, P.C., question for the jury not for the court. 2000 Town Center, Suite 2400, The potential effects of this case are Southfield, Michigan. Our speaker wide-ranging. As you may know, will be Aaron Sherbin of Finkel, materiality is an element of the 26 Whitefield, Selik, Raymond, Ferrara U.S.C. §7206(1) violation, the willful & Feldman, P.C. Our topic will be filing of a false or fraudulent tax the recent revisions in IRS collection return. Traditionally, the court has policies and the implementation instructed the jury if the material of National Standards for certain element had been,met. Now that expenses and the like. Aaron, as practice may no longer be valid. many of you may know, recently co­ Additional recommended reading authored an article in the Michigan of this topic is the Ninth Circuit's Bar Journal on this topic. This en bane opinion, particularly the well meeting will provide an excellent reasoned dissent of Judge Kozinski. opportunity to exchange experiences with respect to these new guidelines. 4. Future Reports Reservations are suggested. If any of you have information or want to share an experience with 3. Recent Developments your fellow practitioners, please drop Recently, the Sixth Circuit held me a note. in the case of Carrol, et al. v. 9 -----~------Reports from the Committees Michigan Tax Lawyer-1st Quarter 1996

Report of the State event that the CAD amendments are held unconstitutional. The law and Local Committee provides for a formula of 60/20/20 in Gregory A. Nowak, Chairperson 1997 and 70/15/15 thereafter. These Price Waterhouse LLP constitutional fallback changes give 200 Renaissance Center, Suite 3900 rise to numerous procedural issues, Detroit, Michigan 48243 particularly in connection with the (313) 568-5282 short 90-day statute of limitations on refund claims contained in MCL 1. Recent Activities. 205.27a(6). We resolved to form a Our last meeting was held on Febru­ subcommittee to study these issues ary 6, 1996, from 9:00 a.m. to 11:30 and potentially prepare recommenda­ a.m. at the office of Price Waterhouse tions to the Department of Treasury in Detroit. Our guest was David or the legislature concerning the Kirvan, administrator of the Single impact of these changes. Any Business Tax Division. Dave pro­ members interested in participating vided a handout summarizing recent in this subcommittee should contact SBT legislation and other current the Committee chairman at (313) SBT issues. He also provided a 568-5282. fascinating behind-the-scenes picture of the SBT Division, and shared a 2. Future Activities. number of remarkable insights with The next meeting of the committee the group. If you missed it, that's a will be held on May 8, 1996, from shame. But it's all the more reason 2:00 p.m. to 4:00 p.m. at the Univer­ to mark your calendars for the next sity Club in Lansing. We are inviting meeting, identified below. the members of the Michigan Senate Among the issues addressed by Finance Committee and the Michigan Mr. Kirvan were the department's House Tax Policy Committee and the current position in connection with staff of those committees to attend the Guardian and Gillette cases, this meeting. Our goal is to initiate including the department's position some dialogue between our commit­ subsequent to the Magnetek case, the tee and the members of the Taxation department's view on the significance Section Council and Michigan's tax of the activities of independent legislators. We have had significant representatives in creating SBT discussion during the section's meet­ nexus, the department's current ings regarding the need for greater instructions to the field audit staff interaction between the tax section in addressing throwback ju,risdiction and the legislature. Hopefully this issues, and the department's current meeting will serve to stimulate a efforts to identify nonfilers under the continuing dialogue that will improve SBT. The group also engaged in a communication between the tax bar discussion regarding the statutory and the state legislature, and ulti­ amendments which take effect begin­ mately serve to improve the quality ning in 1997, the status of the ERISA of tax legislation in the state. preemption cases and related refund claims, and a number of other cur­ 3. Single Business Tax Changes. rent SBT issues. In late December, the Michigan During our meeting with David Legislature passed a package of SBT Kirvan, the committee discussed reforms which will take effect in one highly controversial aspect of the 1997. A detailed summary describing new legislative changes, the alternate these changes has been distributed to C~ apportionment of the tax base in the members of our committee. In short, 10 Reports from the Michigan Tax Lawyer-1st Quarter 1996 Committees the changes shift the SBT apportion­ 5. Revocation of Sales and Use ment formula from the current 50/25/ Tax and Motor Fuel Rules 25 sales/property/payroll formula to The Michigan Department of Trea­ 80/10/10 in 1997 and 1998, to 90/5/5 sury conducted a public hearing on in 1999 and thereafter. The CAD February 12, 1996 in connection with deduction is limited beginning in the rescission of a number of sales 1997 to the cost of Michigan real and and use tax and motor fuel tax rules personal property, multiplied by the which the Department has identified same apportionment percentage as obsolete. The Department has applied to the tax base. An addi­ identified 32 sales and use tax rules tional element of the reforms is a and 5 motor fuel tax rules for rescis­ slight increase in the compensation sion. The Department has indicated limit under the SBT small business that this rescission represents Phase credit, which beginning in 1997 will 1 of a two-phase program. This first phase the credit out between the phase represents the rescission of current limit of $95,000 in officer or rules which are outdated or incorrect shareholder compensation and and are no longer deemed necessary $115,000. as guidance to taxpayers. In the second phase, additional rules which 4. Status of Tax Tribunal Rules need updating or modification but Amendment. which the Department intends to The Michigan Tax Tribunal has retain will be amended. You may advised us that its proposed amend­ contact the Department at 1-800- ments to its rules of practice and 367-6263 for a copy of the rescinded procedure should be submitted to the rules. Joint Committee on Administrative Rules in February or March of 1996. The revised procedures for adopting administrative rules apparently no longer require that JCAR conduct a public hear­ MEETING ALL YOUR VALUATION NEEDS ... ing, and provide for Business Valuation automatic adoption of •Estate and Gift Taxation •ESOPs •Marital Dissolutions •Shareholder Disputes •Succession Planning the rules if JCAR takes Real Estate Appraisal no action within a •Purchase/Sale Advisement •Ad Valorem Tax •Financing •Condemnation •Cost Segregation •Sale/Leaseback specified period of time. The tribunal thus Machinery and Equipment Appraisal expects the revised •Allocation of Purchase Price •Financing •Insurance •Leasing/Residuals •Asset Redeployment •Property Tax rules to take effect by Litigation Support mid-1996. Most of these •Construction Disputes •Intellectual Property • Lost Profits •Business Interruption •Wrongful Termination revisions are intended Mergers and Acquisitions to codify existing tribu­ •Sale/Divestiture Representation •Focused Acquisition Searches •Value Enhancement •Fairness Opinions nal practice or conform For more information call John N. Ross, Director at (810) 932-2950 to recent legislative changes, although some Shanker & Stout Valuation Consultants, Inc. of the provisions do 30445 Northwestern Hwy.• Suite 100 • Farmington Hills, MI 48334 represent substantive Detroit:(810) 932-2950 • Lansing: (517) 484-1310 changes. 11 Feature Articles Michigan Tax Lawyer-1st Quarter 1996 ( The Implied Covenant Not To Compete­ An IRS Red Herring?

Robert L. Cohen, J.D., C.P.A. ment. The Service then draws the Robert A. Bryant, J.D., M.B.A. conclusion that the amortizable value of the written covenant for tax pur­ In recent years, many taxpayers and poses is equal to the value of these the Internal Revenue Service have two benefits, which the Service expended considerable resources asserts is nominal. Consequently, locked in controversy over purchase the consideration assigned by the price allocations to intangible assets, parties to the written covenant that including noncompetition agree­ exceeds the nominal amortizable The written ments. Part One of this two-part value allocated by the Service to the article explored the source of this covenant will typically be reclassified noncompetition controversy, including the procedural as payment for nonamortizable stock agreement posture of the IRS in the typical or goodwill. Part Two of this article entered into by noncompete audit. As explained in ex~mines the Service's implied the parties has Part I, almost all of the IRS Engineer covenant theory. little or no Reports or Revenue Agent Reports amortizable regarding covenants not to compete Michigan Law Does Not Support or noncompetition agreements that value because the IRS Position were received by the authors of this While the Service's argument regard­ the buyer is article since 1992 with respect to ing the impact of the implied cov­ already examinations of Michigan taxpayers enant on the amortizable value of the protected by have included the following argu­ written covenant has some superfi­ the covenant ment: The written noncompetition cial appeal, close scrutiny reveals not to compete agreement entered into by the parties that the argument is without merit. has little or no amortizable value that is implied The Service's casual observation that because the buyer is already pro­ the written covenant provides only a under Michigan tected by the covenant not to compete modicum of certainty reveals a com­ common law. that is implied under Michigan plete misunderstanding of the signifi­ common law. cance of the Colton case and an Based on the Michigan Supreme unrealistic view of the real world of Court's 1931 decision in Colton v. business sales and acquisitions. The DuvalF (and similar cases from other Colton case was decided in 1931. If jurisdictions), the Service's position the Service's view of Colton is accu­ appears to be that the seller of a rate - that it virtually eliminates Michigan business implicitly cov­ the need for, and benefits of, written enants that he will not reclaim or covenants- one would have ex­ interfere with the goodwill of the pected to find the use of such written business sold to the buyer; thus, agreements since 1931 to be the the only benefits secured by a buyer exception rather than the rule. of a business who obtains a written However, following Colton, there covenant not to compete from the are over sixty years of case law seller are: (1) that the seller may not involving written covenants restrict­ seek to obtain the business of poten­ ing competition.2 Moreover, virtually tial new customers that were not every business sale transaction previously served by the seller; and, includes a noncompete provision or a (2) that a written covenant is nor­ separate noncompete agreement mally easier to enforce than the setting forth specific terms that limit unwritten implied covenant con­ the seller's ability to reenter the c 12 tained within the purchase agree- market and compete with the buyer. Feature Michigan Tax Lawyer-1st Quarter 1996 Articles

The parties are seldom willing to may deal with old customers leave such matters to chance or, for coming to him of their own that matter, to Colton. motion.'6 In the 64 years subsequent to the Thus, the Court in Getter ruled Colton decision, the Michigan courts that establishing a competing busi­ have enforced an implied covenant ness three blocks away from the pursuant to Colton only once! That previously owned enterprise, with old decision- Worgess Agency, Inc. v. customers returning of their own Lane (discussed below) - has been volition, was not within the scope of strongly criticized. 3 Furthermore, any covenant that might be implied only two other cases have even in the law. considered Colton. The conspicuous absence of case In the 1932 case of Sloan v. law applying Colton is attributable Charlevoix State Savings Bank, 4 -a to the fact that the Service's implied In general, bank sold an insurance agency it covenant argument is,fundamentally implied had previously operated. Some of flawed as a matter of Michigan the bank's officers set up a competing common law. In general, implied covenants are insurance agency, and the buyer of covenants are not favored by the law, not favored by the business sued. The Michigan but rather will arise only where there the law, but Supreme Court held that the implied is no expression on the subject. 7 ·rather will arise covenant might apply if the bank had Courts have historically refrained only where competed, but that the covenant did from providing implied rights and there is no not extend to the bank's officers. imposing implied duties upon the Then, in 1946, the Michigan Su­ parties, unless the following condi­ expression on preme Court explained the limited tions have existed: the subject. scope of Colton in Getter v. Levine.5 (1) the implication must arise In Getter, the parties had been part­ from the language used or it ners in a vegetable and grocery must be indispensable to effectu­ business for 17 years. Shortly after ate the intention of the parties; the seller sold his interest in the (2) it must appear from the business, the buyer learned that the language used that it was so seller planned to open an identical clearly within the contemplation business only three blocks away. of the parties that they deemed it The buyer brought suit to obtain an unnecessary to express it; (3) injunction restraining the seller from implied covenants can only be opening the competing business. justified on the grounds of legal The Court held for the seller: necessity; (4) a promise can be '[I]n the absence of agreement as implied only where it can be to the right to compete, the rightfully assumed that it would vendor of a business and its good have been made if attention had will is not precluded from engag­ been called to it; (5) there can be ing in a similar business in the no implied covenant where the vicinity provided he does not subject is completely covered by interfere with the purchaser's the contract.8 enjoyment of the premises sold. As noted, the only Michigan court In most jurisdictions the vendor decision to acknowledge the existence of a business and its good will is of an implied covenant under Colton not entitled to solicit the trade of was the Court of Appeals 1976 deci­ customers of the business sold or sion in Worgess Agency, Inc. v. Lane.9 to set up the identical business In Worgess, the principal shareholder or represent the new business as of the selling insurance agency a continuation of the old, but he expressly agreed not to compete for 13 Feature Articles Michigan Tax Lawyer-1st Quarter 1996 ( five years. Following the sale, the freight handling services for his shareholder accepted employment former customers. Is Colton limited with the buyer. Mter seven years of to service providers? The seller in serving the customers which he had Getter was permitted to serve his old sold to the buyer, he left to work for customers that came to him of their a new agency and he solicited his own volition. Does Colton prohibit former customers. The buyer sued, the seller from initiating any contact and the court rejected the seller's with former customers (e.g., advertis­ The bottom line argument that a written covenant not ing)? Given these uncertainties, and to compete by definition precludes when the significant costs and risks is that after any implied covenant. Instead, the that would be associated with a legal more than sixty court remanded the case for a factual proceeding brought to determine the years of determination of the term of the existence and scope of an implied opportunity to implied covenant.10 covenant are considered, it is the rely on the The Worgess case has been implied covenant, not the express Colton decision, strongly criticized for its conclusion covenant, that has little, if any, value. that an implied and express covenant The bottom line is that after more no one does so. could exist simultaneously, since this than sixty years of opportunity to rely appears to be contrary to Michigan on the Colton decision, no one does so. precedent.11 At best, Worgess is an Written covenants not to compete example of the rare instance in which accompany virtually every business a court may be willing to impose an sale. Whatever the theoretical value implied covenant when the facts of the legal prot~ctions provided by reveal a gap in the written agree­ Colton may be, as a practical matter, ment. those protections are regarded as ' A careful reading of Colton reveals worthless by the business world. (oo'! only the following. A buyer of a Moreover, the legal community has business cannot, shortly after selling not embraced Colton, since to sug­ the assets of his business, directly gest, as the IRS has, that an implied solicit his former customers for the legal right that might be applied by a purpose of providing the same ser­ court in a legal proceeding is prefer­ vices previously provided. Beyond able to, or has any effect whatsoever that, the buyer of a business hoping on the value of, a legally-binding to rely on Colton unwisely exposes written agreement that sets forth the himself to the following uncertain­ negotiated rights and obligations of ties: (1) The time period over which the parties is ludicrous. The lesson the implied covenant applies is from Colton and the absence of its unknown. (2) Colton involved a sale progeny is one of legal prudence. To of assets. Does it apply to stock sales be sure, Michigan law clearly favors or redemptions? (3) The extent of the the formation and enforcement of a geographic area within which the negotiated written contract, and seller is prohibited from competing when the written contract and appli­ is not defined by Colton. As noted, a cable case and statutory law all fail fruit and vegetable vendor can appar­ to address a matter of critical impor­ ently set up a new stand only three tance, a court may intercede to fill blocks from the previously owned in the gap.13 Because an implied business (and serve his old custom­ covenant has no legal force without ers) without violating Colton. 12 a court decree, logic dictates that the (4) The scope of competing activities theoretical possibility of an implied prohibited by the implied covenant covenant being imposed by a court is unclear. The seller in Colton was should not reduce the amortizable precluded from performing local value of a written covenant. This is c 14 Feature Michigan Tax Lawyer-1st Quarter 1996 Articles

precisely the conclusion reached by The Tax Court, in a decision acqui­ the only two court cases to address esced in by the IRS, reached the same the issue in the context of a federal conclusion in O'Dell & Co. v. Commis­ tax dispute. sioner. 16 There, the Commissioner asserted the same implied covenant Federal Tax Decisions Reject argument that has appeared recently The Implied Covenant Theory in the Engineer Reports. The Tax In Harvey Radio Laboratories, Inc. v. Court flatly rejected this proposition: 14 Commissioner , the taxpayer sold his [T]he covenant arising by opera­ business and entered into a covenant tion of California law did not not to compete with the buyer. The deprive the express covenant ... sales agreement allocated $45,000 to of economic reality since it was the taxpayer's covenant. The tax­ arguably desirable to define' payer reported the $45,000 as a precisely the rights of the parties capital gain from the sale of goodwill rather than to guess what a rather than as ordinary income from court may decide in the particu­ the covenant not to compete. The lar circumstances, and reason­ taxpayer, adopting precisely the able men, genuinely concerned implied covenant argument currently with their economic future might being asserted bythe Service, argued well prefer to have their rights that since the sale was governed by protected under the compulsion Massachusetts law, under which a of an explicit covenant rather covenant not to compete is implied than to take a chance upon the when a business is sold, the express uncertain coercive power of a covenant had no value. The First possibly inapplicable implied Circuit Court of Appeals disagreed: contract.17 The Massachusetts cases hold That the federal courts have twice merely that, depending on the rejected the implied covenant argu­ facts of a particular sales trans­ ment further reveals the frailty of action, a covenant not to compete the IRS' position. Moreover, the may be implied. No case is cited uncertainties associated with the to the effect that there is an existence and nature of implied implied covenant not to compete covenants in Michigan appear to in every sale, unlimited as to type be identical to the uncertainties of business, area and time. In­ surrounding the common laws of deed, such covenants are ex­ Massachusetts and California. pressly bargained for in Massa­ Michigan common law does not chusetts, apparently because the provide that a covenant not to com­ parties find it desirable to define pete will be implied in every sale of precisely the scope of the cov­ a business, nor does the law provide enant rather than to guess what any certainty regarding the scope of a court may decide is reasonable protection that might exist under an in their case. 15 implied covenant. Accordingly, there Thus, the First Circuit not only is every reason to believe that a tax questioned the scope of the implied case involving an implied covenant covenant that exists under Massa­ litigated under Michigan law would chusetts law (similar doubts surely follow the holdings in Harvey Radio exist under Michigan law), but the and O'Dell. 18 court also recognized that the pru­ dent course of action is to put such Whether Express or Implied­ agreements in writing and carefully Covenants are Amortizable define the parameters. Even assuming, purely for the sake of 15 Feature Articles Michigan Tax Lawyer-1st Quarter 1996 ( argument, that the implied covenant tax purposes, the $300,000 should reduces the value of the written be amortizable.19 This result, at a noncompete agreement, that should minimum, appears to be mandated not change the fact that the total for noncompete agreements governed value of the seller's potential competi­ by Section 197, which provides that tive threat is amortizable. That the "any covenant not to compete en­ value of such competition is attribut­ tered into in connection with an able to the express covenant, the acquisition (directly or indirectly) implied covenant, or both, is of no of an interest in a trade or business" moment. is amortizable.20 Section 197 does By way of illustration, when a not appear to distinguish between person buys a building, he is also express or implied covenants. buying, by law, all of the fixtures attached to the building. The pur­ Conclusion chase agreement may make no men­ Purchase price allocations to written tion of such fixtures, but the existence noncompetition agreements have of those fixtures clearly impacts the been a frequent target of challenge total consideration paid by the buyer. by the Service in recent years, If the buyer is willing to pay $100,000 because of (1) the limited adversity for the building with the fixtures, and of tax interests that often exists $90,000 without the fixtures, then it between a buyer and seller of a follows that the fixtures are worth business, (2) the potential for tax­ $10,000. The value of the fixtures payer misallocations of purchase does not change simply because the price among intangible assets, agreement fails to specifically list (3) the rather subjective nature them. of"valuing'' noncompetition agree­ The same logic applies to the ments, and (4) the taxpayer's heavy implied covenant to which the IRS burden of proving the value of such has been attaching so much signifi­ agreements. 21 The IRS Intangibles cance. For example, assuming that Settlement Initiative helped resolve a business is worth $600,000 with many of these cases, and the enact­ competition from the seller and ment of Section 197 should reduce $900,000 without the seller's com­ the number of situations where petition, the seller's competition is challenges will occur in the future. presumably worth $300,000. If the However, significant tax benefits can seller requests that the buyer waive still be secured by taxpayers that its rights under either an express aggressively allocate purchase price or implied covenant (and there is to noncompetition agreements, at no reason to believe that the parties least when a stock acquisition is could not waive such rights), the involved or a corporate-level tax can buyer would presumably be willing be avoided. Thus, taxpayers can to pay only $600,000 for the seller's expect the IRS to continue to chal­ business, since that amount repre­ lenge allocations that it perceives as sented the value of the seller's busi­ abusive. ness if competition was not precluded. Although the IRS' implied cov­ Whether the $300,000 value of the enant theory at first blush appears seller's noncompetition is attributable to create a significant barrier, a to the written agreement, the implied careful analysis reveals that the IRS covenant, or both, does not alter the theory has no effect whatsoever on fact that such noncompetition had a the amortizable value of a legally total value of $300,000 in the judg­ binding written noncompetition ment of the parties. Therefore, for agreement. The notion that a buyer 16 Feature Michigan Tax Lawyer-1st Quarter 1996 Articles of a business should rely on a cov­ concentrating on Colton, the focus enant that theoretically might be in planning transactions should be implied by a court to protect against on satisfying the economic reality the seller's competition, rather than standard by contemporaneously define the limits of that competition documenting the covenant's value in a written contract, is contrary to through the use of independent business prudence and legal prece­ appraisals or other objective dent. Moreover, both of the court evidence. decisions that addressed the issue in the context of a federal tax dispute have rejected the IRS theory. Consequently, when the buyer of ROBERT L. COHEN is a senior tax consultant with Plante & Moran, LLP. a business pays a negotiated amount Mr. Cohen specializes in corporate for the seller's express agreement not taxation, mergers and acquisitions and tax to compete, the amount paid should controversies. ROBERT A. BRYANT is a be fully amortizable, provided the member of the tax staff at Plante & Moran, agreement satisfies the economic LLP. Mr. Bryant concentrates his practice reality standard (the standard long in estate & gift and international taxation. A special thanks to EMERSON J. used by the courts for establishing ADDISON, JR. for his help in developing the amortizability of noncompetition our implied covenant position. agreements).22 Thus, rather than

17 Feature Articles Michigan Tax Lawyer-1st Quarter 1996

------ENDNOTES 1. 254 Mich. 346, 237 N.W. 48 (1931 ). In Colton, the owner of a local freight handling business sold his business, but shortly thereafter reentered the same business in the same market and contacted his former customers. The Michigan Supreme Court held for the buyer, explaining, "There was an implied covenant on the sale of the good will of the business by defendant that he would not solicit the custom which was paid for and parted with ... Defendant cannot impair the value of what is sold or sell the business and its good will, take the price paid, and keep or retake the thing sold. These principles are elementary and have been repeatedly stated by the English and' American courts." ld. at 347. 2. In 1905, the State of Michigan enacted M.C.L 445.761; M.SA 28.61, which made any contract clause illegal under which a person agreed not to compete unless it was incident to the sale of a business or profession. Effective March 29, 1985, the Michigan Antitrust Reform Act repealed the 1905 legislation. Under the new law, noncompete agreements are permitted so long as they are reasonable as to duration, scope and geographical area. The change in the law did not affect or limit the use of noncompete agree­ ments for business sales. See also Jeffrey A. Levine, Covenant Not to Compete, Nonsolicitation and Trade Secret Provisions of Stock Purchase Agreements, Mich. B. J., November 1985 pp. 1248-49. 3. 66 Mich. App. 538, 239 N.W. 2d 417. See Trade Regulation, 23 Wayne L. Rev. 284, 285-86 (1977). 4. 260 Mich. 291,244 N.W. 477 (1932). 5. 315 Mich. 353, 24 N.W.2d 149 (1946). 6. ld. at 358 (citations omitted). 7. Bobenallnvestment, Inc. v. Giant Super Markets, Inc., 79 Mich. App. 31, 40, 260 N.W.2d 915 (1977); Anderson v. Britt, 375 S.W.2d 250, 260 (Ky. 1963); Smith v. Phlegar, 73 Ariz. 11, 36 P.2d 749, 754 (1951). 8. Cousins lnv. Co. v. Hastings Clothing Co., 45 Cal. App.2d 141 , 113 P .2d 878; Conservative Federal Sav. & Loan Assoc. v. Warnecke, 324 S.W.2d 471 (Mo. App. 1959); Anderson v. Britt, 375 S.W.2d 258 (Ky 1963); Smith v. Phlegar, 73 Ariz 11, 236 P.2d 749 (1951). 9. 66 Mich. App. at 538. 10. On remand, the trial court never discussed Colton, but held the defendant liable for damages based on the court's estimate of business with former customers solicited by the defendant. Opinion of Honorable 1'\ Stanley Everett, 37th Judicial District Court, Calhoun County, Michigan, June 3, 1977. ~ 11. See Trade Regulation, 23 Wayne L. Rev. 284, 285-86 (1977). The Michigan Court of Appeals has held that a contract will not be implied when there is an express contract covering the same subject matter at the same time: As in physics, two solid bodies cannot occupy the same space at the same time, so in law and common sense there cannot be an express and an implied contract for the same thing existing at the same time. This is an axiomatic truth. It is only when parties do not expressly agree that the law interposes and raises a promise. Superior Ambulance Service v. City of Lincoln Park, 19 Mich. App. 655, 663, 173 N.W.2d 236, 239 (1969); see also Campbell v. City of Troy, 42 Mich. App. 534, 537, 202 N. W.2d 547, 549 (1972). 12. Getter, 315 Mich. at 353. 13. Superior Ambulance Service, 19 Mich. App. at 663. 14. 470 F.2d 118 (1st Cir. 1972), 73-1 USTC '119121. 15. ld. at 120 16. 61 T.C. 461 (1974), acq., 1974-2 C.B.3. 17. ld. at469. 18. It is doubtful that the Service's implied covenant argument would have much merit under the common laws of any state, since the American courts have generally been reluctant to embrace implied rights when the parties are free to enter into written contracts. More importantly, even if the courts of a particular state have a preference for implied covenants (however unlikely), the IRS' argument still has no merit as to Michigan taxpayers, based on the state of implied covenant law in Michigan. 19. The IRS might respond, however, that certain rights (such as an implied covenant) which attach to property by law only serve to increase the value of the underlying property (e.g., nonamortizable stock) rather than create a separate amortizable asset. If an implied covenant does create a separate intangible asset, the IRS in a case involving pre-Section 197 law might question whether or not the intangible has a limited useful life that can be determined with reasonable accuracy (i.e., as required under Treas. Reg. Sec. 1.167(a)-3). 20. Section 197(d)(1)(E) (emphasis added). 21. See Part One of this article. Michigan Tax Lawyer, Vol. XXI, Fourth Quarter 1995 pp. 12-17. 22. Id. at pp. 14-15. 18 Feature Michigan Tax Lawyer-1st Quarter 1996 Articles

General Considerations of Nonqualified Deferred Compensation Arrangements Bryan I. Pukoff that nonqualified deferred compensa­ tion plans afford, there are several One of the fundamental consider­ different structures available, ations in any employee benefit depending upon the objectives of program is the use of nonqualified the parties, including: The principal deferred compensation arrange­ goa/of ment(s) ("DCA(s)"). DCAs involve 1. Supplemental executive retire­ employees an agreement by an employer to ment plans ("SERPS") which are make payments to an employee at designed to provide retirement ina DCA is some future date in consideration benefits to a select group of indi­ to delay the for services performed. viduals without satisfying the taxability of the Employer and employee interest requirements of §401(a) (i.e., compensation. in DCAs has been heightened by the qualified plans); Revenue Reconciliation Act of 1993 2. Phantom stock plans which may which, among other things, increased be used to encourage employees individual income tax rates and to meet certain performance decreased the amount of compensa­ objectives of the employer; and tion that may be taken into account 3. Golden handcuff plans which are in determining contributions to structured with forfeiture provi­ qualified plans. DCAs are flexible sions designed to bind an arrangements and are generally not executive's employment. subject to the restrictions imposed on "qualified plans" (e.g. nondiscrimina­ Timing of Tax Consequences­ tion, vesting, coverage requirements, Treatment of the Employee and the amount of compensation that Despite the various motives for may be taken into account in deter­ establishing a DCA and the many mining an employee's benefit different types of structures avail­ amount).1 In addition, there are a able, certain general income tax number of other non-tax reasons why principles are common to all. an employer and an employee may The principal goal of employees enter into this type of arrangement. in a DCA is to delay the taxability For example, if an employee changes of the compensation. This goal may employment, he may forfeit a variety be affected by certain elements that of accrued benefits under the plans are common to most arrangements, of his prior employer. A DCA can be including: funding and other security; designed to compensate the employee voluntary deferral v. nonelective for any amounts previously forfeited. participation; vesting and forfeiture Employers, on the other hand, use provisions; and the formula used to DCAs as performance incentives, to determine the amount of the benefit. 1 attract and retain key employees and As the timing of the employee's tax as tools to enforce noncompetition consequences will depend, in part, agreements. on these elements, the starting point A traditional DCA involves an for analyzing DCAs begins in under­ employee's election to forego current standing the doctrines of constructive payment of compensation, prior to receipt and economic benefit. I earning such compensation, until Under I.R.C. §61, gross income some later date, typically retirement includes "compensation for services, le or upon termination of employment. including fees, commissions, fringe However, because of the flexibility benefits, and similar items.''2 Under 19 I I I I I

Feature I I Articles Michigan Tax Lawyer-1st Quarter 1996

I.R.C. §451, the "amount of any item A bona fide agreement to defer of gross income shall be included the payment of compensation that is in gross income for the taxable year entered into by an employer and an in which received by the taxpayer, employee before the rendering of unless, under the method of account­ services will normally be respected. ing used in computing taxable in­ The doctrine of constructive receipt come, such amount is to be properly is more likely to be asserted in cases accounted for as of a different pe­ were the agreement to defer income riod."3 [emphasis added] is entered into after the related The IRS' view on the taxation of services giving rise to such compen­ DC As is reflected in Rev. Rul. 60-31.4 sation have commenced, but before 5 A bona fide Using a series of examples, the ruling payment is due. 6 provides that an unfunded, unse­ In Veit v. Comr. , the taxpayer was agreement cured promise by an employer to pay employed under a contract providing to defer the an amount of cash to an employee at for the receipt in 1941 of a percentage payment of some time in the future is generally of the employer's 1940 net profits. compensation not taxable to the employee until On November 1, 1940, the parties that is entered payment is actually made by the agreed that the employee's share into by an employer, provided that the agree­ of the net profits should be paid in ment is entered into before the ren­ 1942. The 'Court concluded that the employer and dering of services by the employee. employee did not constructively an employee Based on the foregoing, a cash basis receive the compensation because at before the employee will include deferred com­ the time the agreement was entered rendering of pensation in income, generally, in into, the amount being deferred was services will the year of "receipt." However, the not determinable. In a second Veit 7 normally be concept of what constitutes "receipt" decision, the court found that the has been the subject of much inter­ taxpayer was not in constructive respected. pretation. receipt of income in 1941, reasoning Rev. Rul. 60-31 arose, in part, due that a cash basis taxpayer can effec­ to the application of the doctrine of tively agree to defer income before constructive receipt to DCAs. The the time of payment of the income is doctrine rests upon the basic premise due provided that the agreement is that a taxpayer may not deliberately not a sham. The IRS has acquiesced turn his back upon income and in the first Veit decision, but not the thereby select the year for which second. 8 he will report it. The constructive In Martin v. Comr. , the taxpayer receipt doctrine is embodied in Regu­ adopted a "shadow stock plan" (the lation §1.451-2(a), which states: "Plan") as an incentive for executive "Income although not actually re­ employees. The Plan replaced a duced to a taxpayer's possession is similar plan. At the time of the constructively received by him in the conversion, the participants were taxable year during which it is cred­ given a choice of participating in ited to his account, set apart for him, the new plan or remaining in the old or otherwise made available so that plan. Under the old plan, the only he may draw upon it at any time, or available form of distribution was for so that he could have drawn upon it payment in 10 equal annual install­ during the taxable year if notice of ments. The new plan contained the intention to withdraw had been same distribution option as well as given. However, income is not con­ an option to elect a lump sum distri­ structively received if the taxpayer's bution. Two of the participants control of its receipt is subject to elected to participate in the new plan, substantial limitations or restric­ and shortly after the conversion they 20 tions." terminated their employment. The Feature 11 Michigan Tax Lawyer-1st Quarter 1996 Articles

i{-"i~ IRS contended that these partici- general creditor of the employer. A pants were in constructive receipt of complete discussion of I.R.C. §83 is the value of their stock as they had beyond the scope of this article. the option of rec~iving all of the compensation at once. The court, Securing the Promise however, ruled that the payments As stated above, a mere promise were includible in income when to pay in the future does not alone actually received by the participants trigger constructive receipt. But despite the payment option. The when that promise is funded and/or court reasoned that constructive secured, the taxpayer may be found receipt had not occurred because at to have constructive receipt or to The focus is on the time of the election the payments have had an economic benefit con- what has been were not ascertainable (i.e., the value ferred. Employees' desire for security conferred to of the stock options at the time of of payment tempered by the concern the employee, payment could not be determined). of constructive receipt led to the ignoring the 11 Another theory commonly used to creation of the Rabbi Trust. fact that determine if an employee is taxed A Rabbi Trust is an irrevocable currently on deferred compensation trust, which, because of retained physical is the economic benefit doctrine. This administrative powers by the em- possession doctrine, which is often confused and ployer, is treated as a grantor trust might not be intertwined with the constructive under I.R.C. §§671-679. The income possible or receipt doctrine, provides that an of the trust is taxable to the em- ' that the asset employee may be taxable with re- ployer. In addition, the assets of the cannot be spect to a DCA if he acquires a non- trust are subject to the claims of the forfeitable right in an asset which is general creditors of the employer. immediately as good as cash. The focus is pn what It is this last feature that perhaps is converted - has been conferred to the employee, the most controlling, on the issue of into cash. ignoring the fact that physical pos- whether or not the beneficiaries of session might not be possible or that the trust are in constructive receipt the asset cannot be immediat"ely of the assets. The IRS has provided converted into cash. This doctrine a model Rabbi Trust in Rev. Proc. is most likely to be invoked where 92-64.12, as well as guidance for an employer's obligation to make requesting rulings on DCAs that deferred compensation payments is use such trusts. f;, funded and the employee acquires Some employers use a variation .of an interest in the funding vehicle. the Rabbi Trust, a Secular Trust, to The economic benefit theory was fully secure the payment of deferred partially codified in I.R.C. §83.9 compensation to executives. In a Under this section, if "property" is Secular Trust, the assets are not transferred to an employee as com- available to satisfy the claims of the pensation for the performance of employer's general creditors. This services, the employee will be taxed variation causes the contributions at the time the "property'' is either to be fully taxable to the employee transferable or is no longer subject when they vest (i.e., transferable or to a substantial risk of forfeiture. 10 no longer subject to a substantial For purposes of I.R.C. §83, "property'' risk of forfeiture). does not include money or an un- Another method used to secure funded and unsecured promise to pay payment to an employee is a third- money or "property'' in the future. party guarantee. An argument may Generally, in order to avoid the be made that the guarantee causes application of this Section to a DCA, immediate taxation under the eco- the rights of an employee must be nomic benefit theory. In a number 21 - no better than that of an unsecured, of private letter rulings, however, Feature Articles Michigan Tax Lawyer-1st Quarter 1996

such guarantees have been found not Inc. v. Comr., 18 the DCA provided Another method to result in current taxation.13 There­ that any amounts deferred would used to secure fore, a guarantee may provide an earn an "additional amount" to payment to an employee with additional security reflect the time value of money (i.e. without causing current taxation. "interest"). The employer deducted employee is a the "additional amounts" during the third-party Treatment of the Employer year in which they accrued, instead guarantee. The timing of the employer's deduc­ of when paid to the employee. The tion for DCAs is governed by court concluded that allowing the §404(a)(5).14 Under this provision, taxpayer to deduct such amounts, an employer is generally permitted prior to their receipt by the employee, a deduction (subject to the rules of would contravene the clear purpose §§162, and 212) in the employer's of I.R.C. §404. taxable year that includes the tax­ If a plan, method or arrangement able year-end of the employee in does not defer the receipt of compen­ which such compensation is includ­ sation for more than a brief period ible in gross in~ome. of time after the close of the year in This rule applies whether the which the related services are per­ employer is on the cash or accrual formed, then the employer's deduc­ basis. 15 Section 404 applies to any tion will be governed by the "all plan, method or arrangement which events test" ofi.R.C. §461(h).19 Com­ defers the receipt of compensation. A pensation will be deductible under plan iE? considered to defer the receipt this test if all events have occurred of compensation, and, hence subject which determine the fact and amount to the timing rules of §404, if it of such liability with reasonable provides for the receipt of compensa­ accuracy. tion or benefits more than a brief period of time after the end of the Applicability of ERISA employer's taxable year in which the The broad reach of the Employee services creating the right to such - Retirement Income Security Act of compensation are performed.16 A 197 4 ("ERISA") rules will have some plan is presumed to defer the receipt impact on DCAs. These provisions of compensation or benefits for more govern such matters as eligibility to than a brief period of time after the participate, vesting of benefits, plan end of the employer's taxable year funding, fiduciary responsibility and to the extent that compensation is reporting and disclosure. Plans received after the 15th day of the subject to ERISA are costly to admin­ third calendar month following the ister. A DCA may constitute an close of the taxable year in which the "employee pension benefit plan" related services are rendered ("the which would require compliance 21/2 month period").17 In contrast, a with ERISA. 20 An "employee pension plan, method or arrangement shall benefit plan" is any plan, fund or not be considered as deferring the program that provides retirement receipt of compensation for more income to employees, or results in the than a brief period of time after the deferral of income by employees for end of the employer's taxable year to periods extending to the termination the extent that such compensation is of covered employment or beyond. 21 received by the employee within the However, there is an exception to applicable 21/2 month period. the general rule that exempts the The timing rules of I.R.C. plan from the participation, vesting, §404(a)(5) also apply to amounts benefit funding and fiduciary designated as interest or earnings on responsibilities of ERISA for un­ 22 account balance plans. In Albertson's funded arrangements "primarily for Feature Michigan Tax Lawyer-1st Quarter 1996 Articles

the purpose of providing deferred Recently issued proposed regula­ compensation for a select group of tions clarify when amounts deferred management or highly compensated under or paid from certain employees."22 Plans that meet this nonqualified DCAs are taken into definition will still be required to account as "wages" for purposes of satisfy the reporting requirements the employment taxes imposed by the of Title I of ERISA. These require­ Federal Insurance Contributions Act ments can be met by filing with the (similar proposed regulations were Department of Labor a single state­ issued with respect to employment ment that includes the employer's taxes imposed by the Federal Unem­ name, address, taxpayer identifica­ ployment Tax Act).27 Under tion number, and a declaration that §3121(v)(2)(A), any "amount de­ the employer maintains the plan ferred" under a DCA must be taken primarily for the purpose of providing into account as wages for FICA deferred compensation for a select purposes as of the later of (1) when group of management or highly the services are performed, or (2) compensated employees (a "top-hat when there is no substantial risk group"), the number of such plans of forfeiture of the rights to such maintained by the employer and the amount. number of employees in each plan. 23 The determination of the "amount For purposes of the ERISA report­ deferred" depends on if the benefits ing and disclosure exemptions, an are provided under an "account unfunded plan includes one for which balance" or a "nonaccount balance" ''benefits: (1) are paid as needed plan. A plan will be considered an solely from the general assets of the account balance plan only if: (1) employer; (2) are provided exclusively . principal amounts are credited to an through insurance contracts or individual account for an employee, policies, the premiums for which are (2) the income attributable to the paid for directly by the employer from principal amounts is credited (or it's general assets, issued by an debited) to the individual account insurance company or similar organi­ and (3) the benefits payable to the zation; or (3) both."24 Phantom stock employee are based solely on the plans, Rabbi Trusts and similar balance credited to the individual arrangements will generally consti­ account. This special timing rule tute unfunded programs for purposes may result in the imposition of FICA of this exemption. 25 tax before the benefit payments There is no clear guidance on the under the plan begin. For an account issue ofwhat constitutes a top-hat balance plan the amount deferred group. Each DCA should be analyzed equals the principal amount credited in light of the number of employees to the employee's account for the covered and their compensation level period, increased or decreased by any relative to the general population of income attributable to that amount all employees. through the date such amount is required to be taken into account Withholding and as FICA wages. Employment Taxes If a DCA is not an account balance Wages are broadly defined to include plan, the regulations provide that the "all remuneration ... for services amount deferred for a period equals performed by an employee for the present value of the additional his employer."26 Accordingly, the future payments to which the em­ employer will have to withhold ployee has obtained a legally binding income tax on payments made to right during that period. The regula­ 23 an employee pursuant to a DCA. tions permit the use of reasonable Feature Articles Michigan Tax Lawyer-1st Quarter 1996

assumptions in calculating such imposed by one or more ofl.R.C. present value. §§ 401(a)(17), 401(k), 401(m), 402(g), The Regulations also contain a 403(b), 408(k) or 415, or any other rule of administrative convenience. limitation on contributions or ben­ Under this rule an employer may efits to which any of such sections treat an amount deferred during the apply. year as occurring on any date within the same calendar year. In other Miscellaneous Considerations words, an employer can wait and If a DCA provides for payment treat any amounts deferred that to a beneficiary in the event of an are required to be taken into account employee's death, the beneficiary for FICA purposes as occurring on will ordinarily be required to include If a DCA fails December 31. such payments in income for federal to register with The Regulations also contain a income tax purposes. Such amounts the SEC, a special exclusion (the "nonduplication are generally, "income in respect of rule'') that prevents double taxation. a decedent" under I.R.C. §691(a).29 potential Once an amount under a DCA is Furthermore, the value of a DCA consequence taken into account as wages under will generally be included in an maybe the the special timing rule, the nondupli­ employee's gross estate at death. 30 employees' cation rule provides that neither that If some or all of the assets of a right, for one amount nor the "income attributable DCA are in stock of the employer year, to rescind to that amount" is again treated as maintaining the plan, such plan may FICA wages. be required to register with the their election Securities & Exchange Commission with respect State Taxation of DCAs ("SEC"). If a DCA fails to register to the Recently enacted legislation limits with the SEC, a potential conse­ compensation the ability of states to tax most quence may be the employees' right, deferred. retirement income of their former for one year, to rescind their election residents. 28 Specifically, no state with respect to the compensation may impose an income tax on any _ deferred.31 This one-year recision "retirement income" of an individual right may cause taxation to the who is not a resident or domiciliary employee under the doctrine of of such state(as determined under constructive receipt. the laws of such state). For purposes of this provision, "retirement income" Conclusion includes a DCA if such income is: (1) The use of DCAs in executive plan­ part of a series of substantially equal ning has become increasingly popu­ periodic payments (not less fre­ lar. Given the flexibility they afford, quently than annually) made for the DCA's should continue to play an life or life expectancy of the recipient important role in any compensation (or the joint lives or life expectancies program. of the recipient and the designated beneficiary of the recipient), or for a period of not less than 10 years; or BRYAN I. PUKOFF, C.P.A., J.D. is a Manager with Cendrowski, Selecky and (2) is a payment received after termi­ Reinhart, P.C., a tax and business nation of employment and under a consulting firm located in Bloomfield Hills. plan, program or arrangement (to Mr. Pukoff concentrates his practice in which such employment relates) the areas of real estate, partnerships maintained solely for the purpose and employee benefits. Mr. Pukoff has recently co-authored an article published of providing retirement benefits for in Tax Ideas. employees in excess of the limitation 24 Feature Michigan Tax Lawyer-1st Quarter 1996 Articles

------ENDNOTES

1. I.A. C. §401 (a). 2. I.R.C. §61 (a)(1). 3. I.R.C. §451 (a). 4. Rev. Rul. 60-31, 1960-1 C.B. 174, as modified by Rev. Rul. 64-279, 1964-2 C.B. 121 and Rev. Rul. 70-435, 1970-2 C.B. 100. 5. Robinson v. Comr., 44 T.C. 20 (1965), acq. Rev. Rul 70-435, 1970-2 C. B. 100; Basi/a v. Comr., 36 T.C. 111 (1961), acq. 1962-1 C.B. 3. 6. Veit v. Comr., 8 T.C. 809 (1947), acq., 1947-2 C. B. 4. 7. Veit v. Comr., 8 T.C.M. 919 (1949). 8. Martin v. Comr., 96 T.C. 814 (1991), appeal dism'd (1oth Cir., 1992). 9. I.R.C. §83. 10. Treas. Reg. §1.83-3(b). 11. Priv. Ltr. Rul. 8113107 (December31,1980). 12. Rev. Proc. 92-64, 1992-2 C.B. 422. 13. See, for example, Priv. Ltr. Rul. 8509023 (November-29, 1984). 14. I.R.C. §404(a)(5). 15. H. Rept. No. 95-1445, (PL 95-600) p. 61. 16. Treas. Reg. §1.404(b)-1T, Q&A-2(a). 17. Treas. Reg. §1.404(b)-1T, Q&A-2(b). 18. Albertson's Inc. v. Comr., 95 T.C. 415 (1990), aff'd and vac'd, 94-1 USTC '1150,016 (9th Cir. 1994); On motion for rehearing, 94-2 USTC '1150,619 (9th Cir. 1994) cert. denied. 19. I.A. C. §461 (h). 20. ERISA §3(2). 21. ERISA §3(2). 22. ERISA §201 (2). See DOL Advisory Opinions 75-63 and 75-64 (unfunded Deferred Compensation Plans for "key" employees exempted from Parts 2,3, and 4 of Title I of ERISA). 23. DOL Reg. §2520.1 04-23. 24. DOL Reg. §2520.104-23(d)(2). 25. DOL Advisory Opinion 89-22A (September 21, 1989) and 91-16A (April 5, 1991). 26. I.A. C. §3401 (a). 27. Prop. Treas. Reg. §31.3121(v)(2)-1. 28. H Rept. 104-394, (PL 104-95), (an amendment to Title 4 of the United States Code). 29. I.R.C. §691 (a), Treas. Reg. §1.691 (a)-2(b), Ex. (1). 30. I.R.C. §2039(a). 31. See, E.g., Tax Mgmt. Mem. (BNA), No.2, January 22, 1996.

)- 25 State and Local Tax Update Michigan Tax Lawyer-1st Quarter 1996

Recent Tax: Single Business Tax and interest which accrued to the Case: New York Life Insurance Co v corporation as a consequence of a Cases Dep't of Treasury, Docket No. 204711; payment error made by the bank­ 10/24/95 ruptcy trustee? Court/Tribunal: Michigan Tax Outcome: No penalty is assessable Tribunal to petitioner for nonpayment occa­ Judge: Shinkle sioned by the bankruptcy trustee's Issue: Is petitioner's liability under mistake, although interest is payable. the retaliatory tax provisions of MCL 500.4 76(a) properly reduced Tax: Personal Income Tax by the credit allowed under Case: Bachman v Dep't of Treasury MCL 208.22(c); MSA 7.558(22) for and Mendel v Dep't of Treasury, __ payments made to the Michigan Life Mich App __; __ NW2d __ and Health Insurance Guaranty (1996) Association? Court/Tribunal: Michigan Court Outcome: Payments petitioner made of Appeals to the Michigan Life and Health Judges: MacKenzie/Fitzgerald/ Insurance Guaranty Association are O'Brien not included in the calculation of the Issue: Were nonresidentS corpora­ retaliatory tax on foreign insurers tion shareholders required to remit operating in Michigan. Michigan income tax on distributable income from the corporation engaged Tax: Single Business Tax in business in Michigan? Case: Technicolor Videocassette of Outcome: A nonresident Michigan, Inc v Dep't of Treasury, shareholder's distributive income Docket No. 145984; 11/28/95 from an S corporation doing business Court/Tribunal: Michigan Tax in Michigan is not taxable in Michi­ Tribunal gan under the pre-amendment ver­ Judge: Dean sion ofMCL 206.110(b)(2). Issue: Was petitioner taxable in California so as to avoid the throw- - Tax: Personal Income Tax back of California sales into the Case: Gilson v Dep't of Treasury, numerator of the sales factor of the Docket No. 167283; 1/12/96 apportionment formula? Was peti­ Court/Tribunal: Michigan Court tioner entitled to exclude certain gain of Appeals from its SBT base as a casual trans­ Judge: Bandstra/Markey/Hammond action? Issue: Is § 30(1)(£) of the Income Outcome: Petitioner avoided the Tax Act unconstitutional as applied? throwback of California sales, but Outcome: Section 30(1)(£) of the was not permitted to exclude gain Income Tax Act does not violate the from its SBT base as a casual trans­ Privileges and Immunities, Com­ action. merce or Equal Protection Clauses of the United States Constitution Tax: Sales and Withholding Taxes because it excludes all of the pension Case: Gilbert v Dep't of Treasury, income of Michigan public retirees Docket No. 154570; 12/27/95 and public retirees from other states Court/Tribunal: Michigan Tax which reciprocate the exclusion, but Tribunal includes in tax base the public retire­ Issue: Shinkle ment income received by a public Issue: Was petitioner a responsible pensioner from a non-reciprocating corporate officer liable for penalty state. 26 - State and Local Michigan Tax Lawyer-1st Quarter 1996 Tax Update

Tax: County Real Property Transfer Case: Rose Hill Center, Inc v Holly Tax/Headlee Challenge Twp, Docket No. 190724; 10/23/95 Case: Taxpayers Allied for Constitu­ Court/Tribunal: Michigan Tax tional Taxation v Wayne County, 450 Tribunal Mich 119;537 NW2d 596 (1995) Judge: Shinkle Court/Tribunal: Michigan Supreme Issue: Did petitioner, a residential Court psychiatric rehabilitation center, Judge: Opinion by Boyle/Weaver actively use 370 acres of vacant land concurring in result for hospital or public health purposes Issue: When does the plaintiffs under MCL 211.7(r)? cause of action accrue in a Headlee Outcome: The entirety of the prop­ Amendment challenge to Wayne erty was actively used by the tax­ County's real property transfer tax? payer for hospital or public health Is the one-year limitations period set purposes and thereby qualifies for forth in the Headlee Amendment exemption. constitutional? Outcome: Plaintiffs cause of action Tax: Property TaxNaluation for the tax refund accrued at the time Case: Atisha v Detroit, Docket No. the tax was due; the one-year limita­ 173090; 12/19/95 tions period set forth in the Headlee Court/Tribunal: Michigan Tax Amendment comports with due Tribunal process requirements. Judge: Shinkle/Neumann Issue: What was the true cash value Tax: Headlee Challenge of industrial property for ad valorem Case: American Axle & Manufactur­ property tax purposes? ing, Inc v Hamtramck, Docket No. Outcome: The Tax Tribunal ad­ 220264; 12/15/95 justed petitioner's assessments, Court/Tribunal: Michigan Tax concluding that the majority of the Tribunal value in a multi-story industrial Judge: Shinkle building is in first floor square foot­ Issue: Was the city's spread of 30 age. The Tribunal allowed a 5% mills without voter approval in contamination stigma allowance for obedience to a consent judgment it an underground oil tank on the site, entered into which required it to pay even though no contamination stud­ 100% of the cleanup costs for a con­ ies had been performed by the peti­ taminated development site constitu­ tioner. tional? Does the Michigan Tax Tribunal have jurisdiction over the Tax: Property TaxNaluation petitioner's constitutional attack on Case: Amurcon I Ridgwood Vista v the millage levy? Leoni Twp, Docket No. 96544; 11/07/ Outcome: The Tax Tribunal has 95 jurisdiction to entertain the constitu­ Court/Tribunal: Michigan Tax tional issue presented, as it is within Tribunal its "sphere of expertise." The City's Judge: Morrow/Straatsma millage levy violates Canst 1963, art Issue: What are the cash values of 9, § 6 because it was not authorized petitioner's MSHDN§ 8 subsidized by law or the city charter when the housing project? · Headlee Amendment was ratified, Outcome: Petitioner failed to sus­ and was made without first obtaining tain its burden of proof. Petitioner's voter approval. cash value contentions improperly depended upon an appraisal valuing Tax: Property Tax/Exemption the subject as a conventional project without inclusion of rent subsidies; 27 State and Local Tax Update Michigan Tax Lawyer-1st Quarter 1996

Respondent's evaluation of the Court/Tribunal: Michigan Court market for § 8 properties was more of Appeals convincing. The Tribunal increased Judge: Reilly/Taylor/Kobza petitioner's assessments. Issue: Did the Michigan Tax Tribu­ nal properly grant motions to dismiss Tax: Property Tax.Naluation equalization appeals initiated by Case: Forty West Apartments v several townships? Holland, Docket No. 89788; 10/6/95 Outcome: As to Ferris Township, Court/Tribunal: Michigan Tax the county unlawfully included sales Tribunal of four parcels within its agricultural Judge: Dean sales study when those properties Issue: What are the cash values of were purchased for non-agricultural petitioner's § 236 subsidized housing uses and accordingly were not repre­ project? sentative of the class as a whole. Outcome: Petitioner's income As to Richland Township, the Tax approach which included conven­ Tribunal unlawfully dismissed its tional properties was not credible; the claim that the economic condition Tax Tribunal accepted respondent's factor ("ECF") which the county income approach, but adjusted it by used in its commercial classification 25% to reflect deferred maintenance. appraisal study was excessive. The Tax Tribunal's determination that Tax: Property Tax/Millage this claim'must have been brought Agreement before equalization was finalized Case: Averill et al v Saginaw School in order to preserve it for appeal District, Docket No. 169810; 11/21/95 is inconsistent with the de novo Court/Tribunal: Michigan Court provisions of the Tax Tribunal Act. of Appeals Judge: unpublished per curiam Tax: Personal Property Tax/ Issue: Were plaintiff-taxpayers Ownership entitled to relief consisting of cancel­ Case: General Funding Corp v City lation of a millage agreement be­ of Novi, Docket No. 175008; 11/17/95 tween the Saginaw School District Court/Tribunal: Michigan Court and Zilwaukee Township and an of Appeals injunction? Judge: Unpublished opinion Outcome: The Court of Appeals Issue: Was General Funding the affirmed the trial court, concluding title holder to the property, and that plaintiffs sued the wrong defen­ therefore subject to imposition of dant, inasmuch as MCL 129.61; MSA ad valorem personal property tax? 5.3281 does not authorize Plaintiffs to Outcome: The Michigan Tax Tribu­ file suit against the school district, nal correctly determined that the but instead allowed Plaintiffs to taxpayer leased, rather than owned make a demand for the funds ex­ the equipment, as it was not benefi­ pended from the school district of­ cially entitled to the property, nor ficer, and then, to maintain an action did it possess or have control over on behalf of the school district against the items. the township. PATRICK R. VAN TIFLIN, MICHELE L. Tax: Property Tax/Intracounty HALLORAN and KIM D. CROOKS, Equalization members of the law firm of Howard & Howard Attorneys, P.C. in Lansing, pre­ Case: Fairplains Twp et al v pared the state tax case summaries in this Montcalm County Board of Commrs, issue. __ Mich App __; __ NW2d 28 (11/21/95) -- Short Michigan Tax Lawyer 1st Quarter 1996 Subjects

State Taxation, Vol. I, 2nd Ed. Book Author: Jerome R. Hellerstein and intertwined throughout this analysis Review Walter Hellerstein since most state income taxes prob­ Published by: Warren Gorham Lamont ably conform to the measure of Fed­ 21 0 South Street eral income tax. Chapter 8 and 9 Boston, MA 02111 address the highly technical and Phone: 1-800-950-1205 sometimes nonsensical area of all()ca­ tion and apportionment of corporate State Taxation, Volume I, Second income. The authors provide an Edition represents probably tJ:e most excellent analysis on a unitary busi­ comprehensive and authontatlv_e ness concept that includes a compre­ guide of the sundry of state tax Issues, hensive summary of the holdings of trends, laws and those decisions interrupting those laws. As the cases of approximately half of th~ states. Additionally, this work dis­ authors note, the revenue derived cusses the interstate commerce impli­ from state taxes has more than cations of various state provisions, doubled to 312.8 billion dollars over including an accompanying discussion the past decade. In light of the fact of foreign commerce implicat~ons. . that states have become more aggres­ Chapter 10 discusses certam special sive in collecting revenues from in methods of allocation and apportiOn­ state as well as out of state taxpayers, ment for transportation, publishing, this work is one of the few that have broadcasting, and investment compa­ attempted and succeeded to provide nies and financial businesses. The the tax practitioner with a broad yet last Chapter provides a brief discus­ concise multi-state analysis. sion of capital stock taxes. State Taxation covers the corporate As is always important in an area income and franchise taxes area. of tax law which is under constant More specifically, Chapter 1 begins upheaval, the authors pro·~ride a with a brief introduction of the devel­ timely supplement which mcludes. opment of the state tax system and such ground breaking cases as Qwll provides a useful bibliography of the small number of publications address­ Corp v. North Dakota, Wisconsin Department of Revenue v. Wil_lia;n_ ing the subject of state taxation. Wrigley, Jr., and Harper v. Vzrgmza Chapters 2 through 5, discusses Department of Taxation. ,, constitutional limitations on the In summary, State Taxation, imposition of taxes by states under Volume I provides an indepth and the Equal Protection, Commerce, and yet understandable analysis of _the Import-Export Clauses. Ch~p~er _6 subject of state corporate taxatiOn. discusses when a state has JUnsdiC­ Any tax practitioner who intends on tion to subject an entity to its corpo­ becoming more familiar as well as rate tax. In its extensive coverage of more involved in this area should Public Law 86-272 (the Interstate at the least consider this treatise for Commerce Tax Act), which prevents his or her library. a state from taxing a corporation that only solicits business there, the au­ CYRUS R. KASHEF is an associate in the thors claim this law as the first gen­ Farmington Hills firm of Couzens, Lansky, eral legislation enacted by Congress Fealk, Ellis, Roeder & Lazar, P.C. where that restricts the powers of states to he specializes in state and local tax law, tax interstate business. tax litigation, and business mergers and acquisitions. He is a member of the State Chapter 7 examines what is in­ Bar of Michigan. Mr. Kashef received his cluded in "net income" for state tax J.D. degree from the University of Detroit purposes. The concept of "net income" and his LL.M. in taxation from Boston and the "Federal income tax" are University. 29 Short Subjects Michigan Tax LaWyer-1st Quarter 1996

Shortcuts The Michigan Public Contributions Credit­ A Double Standard? Christopher A McMican Comp. Laws § 208.38 allows a 50% credit to be applied against the Single To encourage charitable contribu­ Business Tax ("SBT") for the aggre­ tions and perhaps t~ ease the govern­ gate amount of corporate contribu­ mental burden of supporting tions made to a qualifying institution. charities, Internal Revenue Code The allowable credit cannot exceed Section 170 provides individual and the lesser of $5,000.00 or 5% of the corporate taxpayers with tax relief tax liability for the year as deter­ for contributions made to designated mined without regard to the credit. While some charities. For this purpose, percent­ Again, to qualify for the credit, the institutions age limits are imposed on the allow­ donation must be made to one of the are qualifying able deduction for both individual institutions enumerated in this and corporate taxpayers. As one statute, which, as can be expected, charities for would expect, the standards that lists organizations such as public. individual allow an institution to qualify as libraries, the Michigan colleges foun­ taxpayers, they charitable are consistent for both dation, and institutions operated will not qualify the individual and for the corporate exclusively for higher learning. if the funds are taxpayer. Michigan also provides Having glossed over each statute, donated by a charitable tax relief in the form of it seems that those institutions that a credit, which is applicable to indi­ qualify for the individual public corporate vidual as well as corporate taxpayers. contributions credit should also entity. However, while some institutions qualify for the SBT public contribu­ are qualifying charities for individual tions credit. Intuitively, there does taxpayers, they will not qualify if not seem to be a reason to differenti­ the funds are donated by a corporate ate based on the status of the donor. entity. However, all current authority indi­ Mich. Comp. Laws § 206.260 cates that contributions to some state provides a credit against individual museums will only qualify for the income taxes imposed by the State of public contributions credit if the Michigan equal to 50% of the aggre"' donor is an individual. gate charitable contributions made If a donation is made to an by a taxpayer during the year; the historical museum, for example, the allowable credit cannot exceed statute's language requires only that $100.00 ($200.00 for a joint return). the museum be considered "a state To qualify for the credit, the contribu­ museum." Pursuant to an inquiry, tion must be made to one of the the Michigan Department of Treasury institutions enumerated in the stat­ indicated that a museum must be ute. Among these institutions are governed by the State's Department public libraries, the Michigan col­ of Education to qualify for the credit. leges foundation, a state museum, Because many public museums are and the department of state for the tax-exempt organizations that are preservation of state archives. The governed not only by the State of statute even contains a specific Michigan, but also by the Department provision that allows the fair market of Education, donations made to these value of art work created by the institutions by an individual taxpayer personal effort of the taxpayer to will usually qualify for the public qualify for the credit. contributions credit. For the corporate taxpayer, Mich. Although the statute providing for 30 --1 Short Michigan Tax Lawyer-1st Quarter 1996 Subjects

the credit against the SBT does not specifically include museums in its CHRISTOPHER A. McMICAN is an list of qualifying institutions, one associate at Clark Hill P.L.C. and special­ would assume that donations to these izes in taxation as well as general business law. He is a graduate of the University of entities would qualify for corporate Florida LL.M. in taxation and the University donors as well. To determine if the of Detroit Masters in Business Administra­ same standard is applied by both tion programs. statutes, I addressed an inquiry to the SBT division of the Michigan Department of Treasury. I was informed that the SBT credit is only available for these type of institu­ tions if they are "organized and operated exclusively for the benefit of higher learning." To qualify as an institution "of higher learning," the statute requires an institution to have a regularly enrolled body of students and to offer education above the twelfth grade. Having no current precedent for circumventing the statute's strict language, a written determination from the Administrator of the Michi­ gan Single Business Tax would, most likely, prove futile. Since it is clear that this provision only applies to schools, donations to an historical museum will not qualify for the SBT public contributions credit. Although this is probably not an issue that will profoundly impact the tax law at any level, this double standard arouses curiosity. Mter all, charitable tax relief is granted to encourage donations that help fund these organizations, which, in turn, helps alleviate some of the burden of support that the government might otherwise assume. Further, restrain­ ing corporations from making these contributions seems to defeat the purpose of charitable tax relief, even if the donations are made for political as well as tax reasons. Without proposing that Michigan align its statutes with the Internal Revenue Code, why doesn't the State simply apply similar standards to similar statutes?

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