Owners of pass-through entities (PTEs), which include S corporations and partnerships, received a year-end gift from the state of Michigan in the form of House Bill 5376, which was signed into law on December 20, 2021. It is expected to save pass-through entity owners nearly $200 million in federal income taxes on an annual basis.
Current PTE Taxation
As a general rule, PTEs (including limited liability companies treated as partnerships for federal income tax purposes) are not taxed at the entity-level in Michigan. Instead, the PTE owners pay the Michigan income tax due on the income of the PTE that is passed through to them. Unfortunately, the ability for individuals to then take an itemized deduction on their federal return for these taxes paid to the state is limited by federal tax law which caps deductions for all state and local taxes (SALT) on a federal return to $10,000 ($5,000 for married individuals filing separately).
A New Tax Option
For individuals who are owners of businesses organized as PTEs, House Bill 5376 will allow the PTEs to elect to pay the Michigan income tax on the PTE taxable income. The taxes paid at the PTE level would be a deduction on the PTE’s federal income tax return and not be subject to the federal SALT limitation that is applicable to individuals. The timing of the deduction would be based on the PTE’s accounting method for federal income tax purposes. The individual owners of electing PTEs are then entitled to claim a tax credit in the amount of their respective shares of the entity-level tax against the Michigan income tax due on their Michigan individual income tax returns.
Electing the New Option
For PTEs wishing to elect in for 2021, the election is due on or before April 15, 2022, by paying the tax. The timing of the deduction on the federal return of the PTE will depend on the deduction rules under the Internal Revenue Code.
Generally, to take advantage of this election, a PTE must make the election by the 15th day of the third month following the close of the entity’s taxable year. For calendar year PTEs, the election was due on March 15, 2022. PTEs that did not elect in for 2022 can elect in next year. Once made, the election is irrevocable for a period of three years.
Reach out to your Warner attorney or to Sean Cook at 313.546.6058 to learn how to take advantage of this new tax opportunity.