New Law Allows for Michigan Flow-Through Entity Tax in Michigan

Are you an owner, shareholder, or partner in an S corporation, partnership, or LLC? If so, a bill recently signed by Michigan Gov. Gretchen Whitmer may apply to your business. On Dec. 20, 2021, Gov. Whitmer signed House Bill 5376 into law, which amends the Michigan Income Tax Act by implementing an elective flow-through entity tax.

A flow-through entity, sometimes called a pass-through entity, is a business entity that passes all its income onto the owners or investors of the business.

Essentially, the law allows individual taxpayers with interests in partnerships or S corporations to reduce their federal income tax by allowing Michigan income taxes to be calculated and paid at the entity level.

Overview of the Flow-Through Entity Tax 2021

The recently signed legislation introduces Chapter 20 within Part 4 of the Income Tax Act to create and levy a flow-through entity tax on electing flow-through entities in Michigan, effective January 1, 2021.

Generally, the flow-through entity tax allows a flow-through entity to elect to pay tax on certain income at the individual income tax rate, with members of that entity eligible to receive a refundable income tax credit equal to the tax previously paid on that income by the flow-through entity.

Though the flow-through entity effectively pays tax that would otherwise be paid by its members, it does not eliminate any of the reporting or return filing requirements of those members under Part 1 or Part 2 of the Income Tax Act. For that reason, the Michigan flow-through entity tax requires the reporting of complementary entity-level and member-level adjustments to fulfill the scope and intended purpose of ensuring that tax is paid only once on income in Michigan. 

Eligibility & Limitations

For this purpose, a “flow-through entity” is defined as “an S corporation or a partnership under the internal revenue code for federal income tax purposes.”

Generally, the following types of common flow-through entities may elect to pay the flow-through entity tax in Michigan: 

• Limited liability companies (LLCs) that file federal income tax returns as partnerships
• Partnerships, including limited partnerships, limited liability partnerships, and general partnerships
• S corporations

However, certain types of flow-through entities are specifically precluded from paying the Michigan flow-through entity tax, including the following:

• Publicly traded partnerships
• Flow-through entities subject to the financial institutions tax under Chapter 13 of Part 2 of the Income Tax Act
• Entities that are disregarded for federal income tax purposes, such as single member LLCs
• LLCs that file federal income tax returns as corporations. 

Entities that are not flow-through entities — such as sole proprietorships or C corporations — are not eligible to pay the flow-through entity tax. While this information is very technical and detailed, it may help many Michigan businesses at tax time. Contact one of our accountants, and we’ll help you understand what this option could mean for you.