Michigan Governor Whitmer signed H.B. 5376 into law on December 20, making Michigan the latest state to allow pass-through entities (PTEs) the option to be taxed at the entity level. The new PTE regime creates a workaround for owners of PTEs doing business in Michigan to the $10,000 federal cap on state and local tax (SALT) deductions that was enacted in the 2017 Tax Cuts and Jobs Act. The election is effective for tax years beginning on and after January 1, 2021.
Entities treated as partnerships or S corporations for federal income tax purposes can elect to be taxed at the entity level. Publicly traded partnerships, disregarded entities and financial institutions cannot make the election in Michigan. Multi-tiered partnerships and PTEs with non-individual owners are not precluded from making the election.
The election must be made by the 15th day of the 3rd month of the first tax year to which the election is to apply. For tax years beginning in 2021 only, the election must be made by April 15, 2022, regardless of tax year end. Unlike many other states that have created elective PTE tax regimes, Michigan’s election is irrevocable and is binding for the year of the election and the subsequent two tax years.
Electing PTEs calculate tax on their positive income tax base, subject to adjustments specified in the bill, after applying Michigan’s individual income tax allocation and apportionment rules. When calculating the elective PTE’s tax, the electing PTE includes only the business income tax base allocable to those members who are individuals, PTEs, estates or trusts. The electing PTE excludes the business income tax base allocable to those members that are corporations, insurance companies or financial institutions. The elective PTE tax rate is tied to Michigan’s individual tax rate, which is currently 4.25%.
Individual owners of electing PTEs may claim a refundable credit for their allocated share of the tax as reported to the member by the electing PTE. Likewise, corporate owners of electing PTEs may also claim a refundable credit for their allocated share of the tax.
Insights
- Stay tuned for a more detailed analysis of Michigan’s new elective PTE tax law, along with the guidance expected to be released by the Department of Treasury.
- Based on informal discussions with Treasury, a notice is in progress and expected to be released by December 27, 2021 that will provide guidance as to how to make Michigan’s election for 2021 before year end. For at least the 2021 tax year, it appears that a form will not be available to make the election by December 31, 2021. Rather, Treasury indicated that payment of the tax for 2021 will constitute making the election. Payments must be made electronically through Michigan Treasury Online, which is expected to be open for payments the week of December 27.
- Because the election is binding for the year of election and two subsequent tax years, it should not be entered into lightly. Taxpayers contemplating making the PTE election should perform a detailed analysis and modeling to determine whether the election is beneficial to the entity, its resident owners and – most importantly – its nonresident owners.