Michigan’s flow-through entity (FTE) tax election was enacted in December 2021, and urgent action may be needed if pass-through entity (PTE) owners are to receive the benefits of the election. Like many other states, Michigan sought a workaround for the $10,000 limitation on state and local tax deductibility imposed by the 2017 Tax Cuts and Jobs Act. The resulting solution — the Michigan FTE tax election — gives eligible S corporations and partnerships the option to pay tax at the entity level, so the owners can reduce federal income taxes owed due to a reduction in the pass-through income received. Additionally, since the owner would receive a refundable tax credit equal to the amount of taxes paid by the FTE, the owner no longer has to pay income taxes on the flow-through income received to the state.
The Michigan FTE tax creates planning opportunities for taxpayers, but making the election comes with a list of administrative considerations. Failing to stay up to date on the election’s nuanced requirements can result in state interest and penalties or can completely invalidate a taxpayer’s ability to make the election for a given tax year or otherwise recognize the benefit of the deduction in the period the income was taxed.
Michigan flow-through entity tax: General reminders
The FTE tax requires some foresight and planning when making the initial election. In order to make an election for the 2024 tax year, taxpayers must submit electronic payment through Michigan Treasury Online (MTO) by March 15, 2024, for calendar year taxpayers or the 15th day of the third month of that tax year for fiscal year filers. Any payment submitted after that date invalidates the election for the tax year. Please note that taxpayers must make all FTE tax payments electronically through MTO. The Michigan Department of Treasury doesn’t accept other payments, such as composite payments or through the MI-1040, when making the FTE election.
Taxpayers must also be aware that the election to pay the Michigan FTE tax is irrevocable for the year in which payment is made and the next two successive years. As a result, 2024 will be the first year that Michigan FTE elections start to drop off after the inaugural tax year of 2021. Taxpayers who elected to pay the Michigan FTE tax for the 2021 tax year must reelect into the tax in 2024.
The due date for the annual return is typically March 31 for calendar year filers or the last day of the third month for fiscal year filers. Since March 31 falls on a Sunday in 2024, the 2023 annual report is due on April 1, 2024, for calendar year filers. Taxpayers should note there is a one-time reduction in the Michigan individual tax rate from 4.25 to 4.05% in effect for tax year 2023. Therefore, it’s possible that FTE payments may have been overstated and that some taxpayers are owed refunds. Generally, the refunds received would be taxable and therefore, additional federal income tax could be due.
For more information on the Michigan FTE tax election and payment requirements, visit the Michigan Department of Treasury website.
Transaction considerations for Michigan flow-through entity tax
The Michigan FTE tax election warrants serious consideration from taxpayers who expect to either buy or sell. For sellers, the Michigan FTE tax election could be limited or lost completely, depending on the structure of the transaction or if payments aren’t otherwise made timely.
Taxpayers — particularly the seller of a business — may need to accelerate certain actions to ensure they can receive the benefit of the FTE tax election down the road. This includes submitting a timely election. In addition, taxpayers should consider making all estimated payments within the year. This precaution ensures that the all-events test is met and the federal deduction is fully tied to the period in which the gain is recognized. Finally, taxpayers may wish to proactively make the Michigan FTE tax election if a sale might occur during the year to protect the federal deduction.
Next steps for taxpayers
The timing of election and payment requirements demands foresight and planning for any taxpayers interested in making the Michigan FTE tax election for the 2024 tax year. Taxpayers wanting to determine the merits of making the election must arrange for a prompt review of their unique situation and the impact on any potential M&A activity by March 15, 2024.
