By Dan Schulte, J.D.
MDA Legal Counsel
From the June 2009 issue of the Journal
Question: My accountant tells me that I cannot deduct the costs of dental materials and supplies I use in my practice on my Michigan tax return this year. As you can imagine, I incur significant costs for these materials and supplies. They are deductible on my federal return. Why not on the Michigan return?
Answer: The federal Internal Revenue Code uses a dramatically different system for determining your tax than does the state of Michigan. Do not attempt to make any comparisons. Instead, let’s focus on Michigan law.
The Michigan Business Tax Act (“MBT”) contains two different tax calculations. You must pay the total of the two. The first is the business income tax, and the second is the modified gross receipts tax.
Your cost of materials and supplies should be deductible in computing your business income tax. In computing your modified gross receipts tax the MBT Act allows a deduction for “purchases from other firms.” These purchases are defined in section 113(6) of the MBT Act to include, among other things: “(c) to the extent not included in inventory or depreciable property, materials and supplies, including repair parts and fuel.”
It seems clear that section 113(6)(c) makes your cost of materials and supplies deductible when determining your modified gross receipts tax. However, it is not that clear. For whatever reason, the Michigan Department of Treasury has taken the position that there is no deduction for the cost of your materials and supplies when computing your modified gross receipts tax unless you can show that the materials and supplies are “used or consumed in, and directly connected to, the production of inventory and the operation and maintenance of depreciable assets.”
In the instructions to the Michigan MBT Return, the Michigan Department of Treasury provides the following example to illustrate this additional requirement not found in the MBT Act:
“For example, a physician’s or dentist’s purchase of sterilizing solution during the tax year that is used to sterilize examination equipment, such as an X-Ray machine, may be considered materials and supplies under MCL 208.1113(6)(c).”
The Michigan Department of Treasury has taken the position that materials and supplies that are consumed in the process of treating patients of the practice (e.g., gloves, drugs, gauze, dental appliances, X-ray film, etc.) are not deductible, as they do not contribute to the production of inventory or the maintenance or repair of depreciable assets.
The statute does not contain the treasury department’s additional requirement that the materials and supplies be directly connected to the production of inventory or the operation or maintenance of depreciable assets. This difference could be significant for dentists, physicians, and other health care practices that routinely purchase significant amounts of materials and supplies consumed in the treatment of their patients. Under the Michigan Department of Treasury’s interpretation, these costs are not deductible when computing the modified gross receipts tax portion of the MBT. This is why your accountant is telling you that these costs are not deductible on your Michigan return.
Only time will tell if the treasury department’s more narrow view of the scope of the materials and supplies deduction will be challenged in court. Some taxpayer may take the position that the treasury interpretation is irreconcilable with the clear language of the statute. A court may enter an order overturning the treasury’s position.
Unless and until this issue has been resolved by a court, it appears clear that the Michigan Department of Treasury will only be allowing materials and supplies deductions when the materials and supplies are consumed in the production of inventory or the operation and maintenance of depreciable assets — and not when the materials and supplies are consumed in treating patients.