Maxitrol Co. v. Department of Treasury ( 1996 )

551 N.W.2d 471 (1996) 217 Mich. App. 366

MAXITROL COMPANY, Frank Kern, Jr., and Lucille Kern, Petitioners-Appellees,
v.
DEPARTMENT OF TREASURY, Respondent-Appellant.

Docket No. 178175.

Court of Appeals of Michigan.

Submitted May 14, 1996, at Lansing. Decided June 28, 1996, at 9:00 a.m. Released for Publication August 12, 1996.

Howard & Howard Attorneys, P.C., by Michele L. Halloran and Patrick R. Van Tiflin, Lansing, for petitioners.

Frank J. Kelley, Attorney General, Thomas L. Casey, Solicitor General, and Ross H. Bishop, Assistant Attorney General, for respondent.

Before HOEKSTRA, P.J., and MICHAEL J. KELLY and GRAVES,^[*] JJ.

MICHAEL J. KELLY, Judge.

Respondent appeals as of right from a June 24, 1994, opinion and judgment of the Michigan Tax Tribunal canceling respondent's tax assessments against petitioners.

Maxitrol Company is a subchapter S corporation for federal income tax purposes. A subchapter S corporation refers to a small business corporation that meets the requirements set forth in § 1363 of the Internal Revenue Code, IRC § 1363. In general, an S corporation,

with limited exceptions, is not taxed at the corporate level. Instead, its items of income, loss, deduction and credit are passed through to, and taken into account by, its shareholders in computing their individual tax liabilities. [RIA Federal Tax Handbook (1995), § 3362, p 487.]

Petitioner Frank Kern is the sole shareholder in Maxitrol Company. Petitioner Lucille Kern is his spouse.

During the years 1985-88, Maxitrol paid the Michigan intangibles tax on behalf of Frank Kern. Maxitrol deducted the amount of tax it paid on his behalf from its ordinary income on its federal income tax return, a calculation properly made pursuant to IRC § 164(e), which states:

Taxes of shareholder paid by corporation. Where a corporation pays a tax imposed on a shareholder on his interest as a shareholder, and where the shareholder does not reimburse the corporation, then

(1) the deduction allowed by subsection (a) shall be allowed to the corporation, and

(2) no deduction shall be allowed the shareholder for such tax.

Maxitrol did not separately state the deduction from its ordinary income calculation. At issue here is Maxitrol's duty to pay taxes in Michigan pursuant to the Michigan Single Business Tax Act. M.C.L. § 208.1 et seq.; M.S.A. § 7.558(1) et seq. Because Maxitrol deducted the payment of Michigan intangibles taxes that it made on behalf of Frank Kern from its federal taxable income, its obligation for single business tax payments was correspondingly reduced. Maxitrol's deduction also reduced the Kerns' federal adjusted gross income, which correspondingly reduced their individual Michigan taxable income.

Respondent audited petitioners and assessed separately to Maxitrol and the Kerns the amount that respondent computed petitioners had been deficient in their tax payments because of respondent's conclusion that Maxitrol took improper deductions. Maxitrol and the Kerns filed separate petitions with the Michigan Tax Tribunal to review respondent's tax assessments. The two cases were consolidated below.

Respondent argued below that because IRC § 164(e) was not applicable to Maxitrol, Maxitrol improperly deducted the payment of taxes it paid on behalf of Frank Kern and, thus, that the improper deduction taken at the federal tax level resulted in a deficient payment of Michigan taxes by Maxitrol and the Kerns. Moreover, respondent argued that Maxitrol should have separately stated the deduction so that the Kerns would have had to pay income tax with respect to the deduction taken by Maxitrol. The core of the dispute revolves around the applicability of IRC § 164(e) to subchapter S corporations. The Tax Tribunal held that section was applicable to all corporations. The Tax Tribunal also held that respondent did not have the authority to audit petitioners' federal income tax returns for the accuracy and applicability of deductions that had been accepted by the Internal Revenue Service. We affirm in part and reverse in part.

I

We believe the Tax Tribunal correctly held that IRC § 164(e) applies to subchapter S corporations. IRC § 164(e) is a general provision dealing with payments made by corporations. IRC § 1363(b) provides that a subchapter S corporation must calculate its taxes like an individual. Respondent takes the position that because IRC § 164(e) does not apply to individuals, it should not apply to Maxitrol.

The tribunal relied on federal and state authority for its interpretation that because Congress specifically used the word "corporations" in IRC § 164(e) without referring to any specific type of corporation, Congress must have intended to have IRC § 164(e) refer to all corporations. Moreover, even the treasury regulations refer to "banks and other corporations." Treas. Reg. § 1.164-7 (1960). Therefore, Maxitrol had the right to take a deduction under IRC § 164(e).

This Court reviews a decision of the Tax Tribunal to determine whether the tribunal erred in applying the law or adopted a wrong principle. We generally defer to the Tax Tribunal's interpretation of a statute that it is delegated to administer. Thrifty Royal Oak, Inc. v. Royal Oak, 208 Mich.App. 707, 528 N.W.2d 205 (1995).

The Tax Tribunal stated two main reasons for its ruling that IRC § 164(e) was applicable to Maxitrol: (1) case law applying IRC § 164(e) uses the general language "corporations"; thus, the tribunal implied that the deduction would be applicable to S corporations; and (2) IRC § 164(e) and the treasury regulations also use the general language "corporations"; thus, the tribunal implied that the deduction applies to S corporations.

The Tax Tribunal's reliance on case law was arguably subject, we think, to another interpretation. The Tax Tribunal relied mainly on Hillsboro Nat'l Bank v. Comm'r of Internal Revenue, 460 U.S. 370, 103 S. Ct. 1134, 75 L. Ed. 2d 130 (1983), to support its conclusion that IRC § 164(e) applies to S corporations. Rather than relying on the reasoning in Hillsboro to apply the rule of law set forth in Hillsboro to S corporations, the Tax Tribunal relied on the general language used in the case to support the proposition that Hillsboro did not limit its holding only to banking institutions. Thus, the Tax Tribunal held that IRC § 164(e) could be applicable to S corporations.

The Tax Tribunal's reasoning was disputable. Courts can rule only on the issues presented before them. The issue whether S corporations may use the deduction set forth in IRC § 164(e) was not before the Hillsboro Court. However, we have found no authority for the respondent's assertion that IRC § 164(e) exists as a general provision applicable solely to the payment of tax by C corporations to the wholesale exclusion of S corporations. Granting deference to the Tax Tribunal's interpretation, we cannot say that it is clearly erroneous. We therefore affirm the Tax Tribunal's decision to permit the deduction to S corporations.

II

Respondent next claims that contrary to the Tax Tribunal's ruling with regard to the issue of respondent's authority to audit, the tribunal has misinterpreted the Legislature's statutory grant of authority in M.C.L. § 205.21; M.S.A. § 7.657(21). We agree with the Department of Treasury with regard to this issue.

Because petitioners' Michigan tax returns depend on the computations in their federal tax returns and statements, the Michigan and federal tax returns are inextricably intertwined, and, unless respondent is permitted to make its own assessment of the validity of petitioners' claimed deductions on their federal income tax statements and returns, the Michigan audit would be so limited and superficial as to be totally inadequate. We hold that respondent had the authority to assess the propriety of the deductions taken and the statements made on the petitioners' federal tax returns in connection with the deductions taken by Maxitrol for Mr. Kern's intangibles tax obligations during the years that were the subject of respondent's audits of petitioners' Michigan tax returns. We find, therefore, that the Tax Tribunal erred in prohibiting respondent from assessing the validity of the federal tax statements. Respondent has the express authority to audit Michigan tax returns, and that express authority necessarily includes the authority to assess the validity of the federal tax statements upon which Michigan tax computations depend.

Affirmed in part and reversed in part.

NOTES

[*] James M. Graves, Jr., 14th Judicial Circuit Judge, sitting on Court of Appeals by assignment pursuant to Const.1963, Art. 6, Sec. 23, as amended 1968.