On Dec. 20, 2021, Michigan Gov. Whitmer signed House Bill 5376 into law, which amended the Michigan Income Tax Act by implementing an elective flow-through entity tax. Retroactively effective for tax years beginning on or after January 1, 2021, the law allows individual taxpayers with interests in partnerships or S corporations to reduce their federal income tax burden by allowing Michigan income taxes to be calculated and paid at the entity level. If the election is made – it’s effective for a 3 year period – the year the election is made and 2 successive years.
This optional flow-through entity tax acts as a workaround to the state and local taxes (“SALT”) cap, which was introduced in the Tax Cuts and Jobs Act of 2017 to limit the amount of SALT allowed as a federal itemized deduction to $10,000.
GreenStone’s tax and accounting department has spent time evaluating the possible benefits and impacts for our customers and have come up with numerous items for customers to know and consider:
- Who can make this election? It’s available for Partnerships and S corporations – so those of you that file tax returns for an LLC (1065) or an S-Corporation (1120S). This is not eligible for C-Corporations, Sole Proprietorships, or disregarded entities.
- How will this impact my total taxes? It will have relatively no impact on total Michigan income tax – it’s expected to be a neutral change for those purposes. If you pay Michigan state income tax at the entity level, it will make the flow-through entity tax portion deductible for federal tax purposes. So, you will save on income taxes paid at the federal level.
- What are the benefits to this election? Tax savings at the federal level!
- What are some potential impacts I should consider related to making this election? Items to consider include:
- The flow-through entity tax payments will be made via Michigan Treasury Online (“MTO”) (Michigan Treasury Online). So you may need to have an account established with them. If you have payroll, you likely already have one. If you don’t, that is a process you’ll have to work through – and pretty quickly! You can also have your tax accountant pay it via their MTO account using the guest services option. Our understanding is that the annual return and final payment is due at the earlier of the date you file your entity tax returns or March 31 – but for this year the return and payments will be accepted with interest, but no penalties enforced through April 15, 2022.
- For cash basis taxpayers, entity level tax payments must have been made by December 31, 2021, to deduct such taxes on their individual federal tax return (1040) in 2021 – payments made after that date will be deductible on the 2022 individual federal tax return.
- Quarterly estimated “entity” flow-through tax payments will be required in 2022 if entity level tax is reasonably expected to exceed $800 and will be a requirement going forward as long as this election is in effect. We do not yet know if the farmer exceptions for quarterly individual estimated income tax payments will apply to this new flow-through entity level tax.
- The State of Michigan has been slow with processing refunds, especially those with PA-116 credits. How slow will they be with refunding for entity taxes paid? Or those with entity tax paid and PA-116 credits?
- One potential issue we’ve identified relates to individuals with PA-116 credits. For example, some of you may have profitable flow-through entities that generate taxable income, but historically you pay very little Michigan income tax due to PA-116 credits. If this flow-through entity election is made, you’d pay tax at the entity level during the course of the year. Then receive a larger refund at the individual level when you file your taxes. So, there’s some time value of money considerations to be made.
- There’s an annual report to be filed for the entity level tax and its allocation to members on a pro-rata basis – this is due by March 31, unless extended until September 30.
- You can also make this election to start in 2022 if you make the election by March 15, 2022.
How is GreenStone approaching the Michigan Flow-Through Entity Tax changes?
This election is definitely a benefit at the federal level for those that pay state income taxes attributable to flow-through entity income. The more state income taxes you pay related to flow-through entity income, the more the benefit. It’s definitely complicated though – so GreenStone will be completing expeditious reviews of our customers’ individual tax situations and the possible benefits of making the election on a one-by-one basis and discuss options with our customers.
What should you do with this information?
You should talk to your tax accountant about this election. They should be able to do a high level estimate of the benefit to you looking at historical Michigan income taxes paid and your federal effective tax rate. Then you’ll need to decide if making the election and the federal tax savings is worth going through the extra hoops required. Be prepared to pay your tax accountant more this year if you make this election. This will definitely mean more time for them to complete your taxes and assist, if necessary, in the entity level tax reporting requirements.
If you are interested in learning more about anything you read within this article, contact your tax accountant, CPA or a local GreenStone branch. GreenStone offers a full array of accounting services for farmers and business owners.