Attention owners of partnerships and S-corporations! We have good news for you as we turn the calendar to 2022. On Monday, December 20, 2021, Governor Whitmer signed into law House Bill 5376, which will allow pass-through entities to make an election to pay Michigan income tax at the entity level, as opposed to paying the tax at the individual level. In order to understand why this is a win, we must first provide some additional context.
Back in 2017, we had the passage of the Tax Cuts and Jobs Act. This created numerous tax law changes, one of them being a new limitation on the amount of state and local taxes (SALT) that an individual taxpayer (who itemizes their deductions) is allowed to deduct. SALT is primarily made up of state & local income taxes and property taxes. The Tax Cuts and Jobs Act capped the deduction at $10,000. Therefore, individuals with state & local income taxes and/or property taxes exceeding the $10,000 limit saw an increase in their tax burden due to the lost deduction.
In response to this Federal tax law change, a number of states set-out to devise a workaround on this limitation. At first, we only saw the high-income states like New York and California, where the residents pay the highest amounts of state income tax, taking action. But now we’re seeing more and more states address this matter, including Michigan with the passage of HB 5376.
As previously mentioned, HB 5376 will allow pass-through entities to make an election to pay Michigan income tax at the entity level. Reminder that owners of pass-through entities report the business income and pay the associated tax on their personal return. Pass-through entities typically do not pay any income tax. Under HB 5376, entities that make the election will be able to deduct the Michigan income taxes on the business income tax return, which is not subject to the $10,000 limitation. This additional deduction will reduce the Federal income tax liability on the owner’s personal income tax return.
The election can be made beginning with the 2021 tax year. The election must be made by April 15, 2022 in order to be effective retroactively for 2021. Once the election is made it is irrevocable for two years.
Please contact Michael Stodulski or any member of the Baker Holtz team at 616-458-1835 if you have any questions regarding HB 5376 and making the election.