Michigan Court Ruling Reveals Refund Opportunity for Services Providers Paying City Income Tax

Taxpayers that file city income taxes in Michigan may have refund opportunities if they have been sourcing revenues based on where services were performed

Certain states, including Michigan, permit cities within their boundaries to assess an income tax at the local level. These taxes are in addition to any other applicable state and federal income taxes and can represent a significant cost of doing business in the state. Michigan cities that wish to assess a local income tax may only do so by incorporating the state’s uniform city income tax ordinance into their own local ordinances.[1] This uniform ordinance standardizes the way city taxable income may be computed, including how an individual or business’ total income is apportioned to the city. In January, the Michigan Court of Appeals issued a ruling that sided with the taxpayer’s position on apportioning service revenue for Detroit’s City Income Tax.[2] Since all Michigan cities with an income tax adopt the same ordinance, the outcome of the ruling impacts not only service providers in Detroit but those conducting business in all Michigan cities. Therefore, refund opportunities may be available for those taxpayer’s providing services in any Michigan city with a local income tax.

Honigman Miller Schwartz and Cohn LLP (“Honigman”), a law firm based in Detroit with additional locations outside the city, sourced its revenues from the performance of legal services based on the location of their clients for purposes of the city’s income tax. The City of Detroit challenged this position, asserting the revenues from the performance of legal service within the city limits should instead be sourced based on the location of performance (i.e., Detroit). Given the amount of legal services performed from the law firm’s Detroit location, this change would have resulted in a substantial increase in city income tax liability.

Under the standardized city income tax rule, businesses with activities both within and without the city are required to apportion their income based on a three-factor business allocation percentage, which takes into account a measure of a business’ property, payroll, and sales attributable to the city relative to its total property, payroll and sales.[3] The issue in the case involves the interpretation of how revenues from the performance of services should be attributed to the city for this business allocation percentage.

The business allocation statutes do not explicitly instruct how to source revenues from services and only direct taxpayers to ascertain the percentage of gross revenue derived from “services rendered” in the city.[4] Honigman interpreted this rule by sourcing its revenues to the location where their clients received their services, based on the actual location of the client. On the other hand, the city argued that revenues from services should be sourced to the location from where the services are performed, which would include all revenues from services performed from Honigman’s Detroit office regardless of client location.

Ultimately, the court agreed with Honigman’s position on three grounds. First, if the legislature intended that revenues be sourced based on where the services are performed, it could have used the phrase “services performed” instead of “services rendered.” In fact, the legislature used the term “services performed” with regard to sourcing compensation, suggesting that “services rendered” should have a different meaning. Second, while the meaning of “services rendered” is not well developed, the remainder of the relevant statute[5] predominantly discusses sourcing revenues based on the destination of the sale. Finally, a contemporary definition of the word “render” from the time the uniform ordinance was adopted refers to transmittal or delivery, in contrast to the city’s conclusion that “render” implied performance.

As a result of this ruling, taxpayers that file city income taxes may have refund opportunities if they have been sourcing revenues based on where services were performed. It is possible that the City of Detroit will appeal this case to the Michigan Supreme Court, so there is some uncertainly regarding the finality of this decision. Nonetheless, taxpayers with refund claims should file them now so that the statute of limitations does not expire on an earlier year while waiting to see if the case will be appealed and for a decision by the Michigan Supreme Court. Aprio’s SALT team has experience advising on apportionment and sourcing rules in all states and localities to help businesses minimize their effective state and local income tax rates. We constantly monitor these and other important state tax issues in order to assist you with your specific tax situation, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the February 2018 SALT Newsletter. 

[1] MI Comp. Laws §141.503(1)

[2] Honigman Miller Schwartz and Cohn LLP v. City of Detroit, Docket No. 336175 (Mich. Ct. of App., January 18, 2018).

[3] See MI Comp. Laws §§141.618 & 141.620. The business allocation percentage method is required unless the taxpayer petitions for the use of an alternate method.

[4] MI Comp. Laws §141.623

[5] MI Comp. Laws §141.623

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