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New Michigan Tax Act May Help Deduct State and Local Taxes

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On December 20, Governor Whitmer signed into law PA 135 of 2021, which amends the Income Tax Act to create a flow-through entity tax in Michigan. This allows certain pass-through entities to pay the state and local tax on behalf of their members and partners instead of the individual member or partner paying it. This is a workaround to the $10,000 SALT cap that currently exists on Schedule A of your personal 1040.

This election is not available to disregarded entities and is also irrevocable for the following two years. Individual partners and members will receive a credit on their personal return equal to their allocated share of tax paid by the flow-through entity.

This law is retroactive to tax years beginning January 1, 2021, so some taxpayers may want to act before the end of the year to benefit. Annual returns are generally due by March 31, with an extension available until April 15, and require estimated payments to be made for safe harbor to avoid underpayment penalties and interest. Treasury has indicated no penalties will be imposed on any taxpayer making this election to file for 2021, provided the tax is paid by April 15. Interest may still apply, though, if it is paid after March 31 as the Treasury Department has not indicated what it will do for this initial year.

Anyone wanting to make a payment may do so online starting December 29. All payments will be required to be paid online through Michigan Treasury Online (MTO). A payment submitted timely through MTO will be deemed to be a valid election for the tax year specified on the payment. Once payments can be made, additional information will be posted directly on the MTO website.

Cash basis taxpayers interested in receiving a benefit in 2021 may want to act quickly and get a payment in by December 31 for it to be considered an expense on your 2021 federal return.

The Michigan Department of Treasury will issue further guidance on this tax in early January 2022.

Our office will monitor this guidance and provide additional details as they become available. Please get in touch with us at maner@manercpa.com with any questions or concerns.

Tax Return Example

In this example, the tax payer is filing a joint tax return for 2021 with total taxable income in the 37% tax bracket and has the following SALT deductions on Schedule A:

  • Real Estate Taxes – $5,000
  • State Income Taxes Paid through W-2 Withholding – $2,000
  • State Income Taxes paid through estimates – $23,375

Currently, on the taxpayer’s 1040, they paid the $23,375 through quarterly estimates. Because of the SALT deduction limitations, you only get to deduct $3,000 to arrive at a taxable income of $700,000 in our example. They effectively lose $20,375 of the deduction.

By making this election, the S Corporation pays the $23,375 in estimates directly to the state, which creates a business tax deduction (method of accounting matters on when payments get made). The itemized deductions drop by $3,000 since now the tax payer only have $7,000 in taxes paid (So 10,000 – 7,000). The net change between the business and itemized deductions is $20,375 (23,375-3,000). Therefore, the taxable income decreases by the $20,375, a decrease of $7,539.

Every tax situation is different and actual savings will vary depending on your specific situation. In some cases, the savings may be minimal or zero, so it won’t be worth electing to pay the tax at the corporate level. Contact Maner Costerisan to review and discuss your tax situation to see if this option makes sense for you.

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