Michigan’s Elective Flow-Through Entity Tax: Time to Opt Back In?
At the end of 2021, Michigan’s governor and legislature teamed up to provide taxpayers who operate certain flow-through entities an (opt-in) opportunity to recover some of the federal tax benefits that the Tax Cuts and Jobs Act took away. Qualified taxpayers who opted-into paying their (personal) state tax at the entity level became able to, in effect, have that state tax deducted from the flow-through income that they reported on their (personal) federal income tax returns.
In 2017, the Tax Cuts and Jobs Act (TCJA) established a $10,000 limit on the State And Local Tax deductions that taxpayers can claim on Schedule A of their tax returns, for tax years between 2018 and 2025. While many aspects of the TCJA lowered taxes on various sectors of the American population, the “SALT Cap” (State And Local Tax deductions) tended to raise taxes on those taxpayers who itemized their deductions and did not take the standard deduction.
In 2018, Connecticut first enacted a flow-through entity (FTE) tax that was a workaround to the SALT deduction cap. While final regulations have not yet been proposed, in November 2020, the IRS published a Notice indicating that FTE workarounds would be permitted. Michigan and at least 36 other states have accepted this invitation and have engineered various SALT Cap work-arounds for flow-through entities.
Michigan’s Public Act 135 of 2021 established our elective flow-through entity tax. This FTE tax can be opted-into by partnerships; S corporations; and LLCs that file federal income tax returns as partnership or S corporations. This tax (and associated benefit) is not available for disregarded entities and Form 1040 Schedule C businesses.
An entity can only opt-into the tax by paying the tax on the Michigan Treasury Online website. Once the election is made, it is binding for that year and the subsequent two years. Loss carryforwards are not allowed for entities that opt-into the tax, so partnerships and S corporations that benefit from loss carryforwards should not hurry to opt-in.
While the statute made tax retroactive to January 1, 2021, its enactment in mid-December 2021 meant that most entities were not able to opt-in until 2022. Entities that first opted-in in 2022, are included until December 31, 2024. After that, they will need to make another payment through Michigan Treasury Online between January 1 and March 15, 2025, in order to renew their election to opt-in. The election must be renewed every three years.
While the SALT Cap is presently set to expire at the end of 2025, it is always possible that a current or future Congress may extend the Cap further into the future before its stated expiration date arrives.
The business, tax, and estate planning attorneys of Mitzel Law Group would be glad to discuss your entity’s situation with you and to help you plan to take advantage of all tax benefits that apply to your circumstances.
