On January 17, Michigan Gov. Gretchen Whitmer signed H.B. 5022 (Public Act 216 of 2024), a taxpayer-friendly bill that makes welcome changes to the state’s flow-through entity (FTE) tax rules. The new rules are effective retroactively to tax years beginning on or after January 1, 2024. Highlights include:
- A new due date to make the election;
- Expanded safe harbor provisions for estimated taxes; and
- Updated disclosure and timing of tax credits based on the above changes.
Election Timing
Before the law change, an FTE had to make an election by the 15th day of the 3rd month of the tax year to which the election would apply. For example, a calendar-year-end FTE had to make the FTE tax election by March 15, 2024, for the election to be valid for the 2024 tax year. For many FTEs, it was only after the election deadline that there was enough information to confirm whether the election — which was binding for three tax years — should be made. Under that timing, Michigan was one of only a few states that required taxpayers to make an election during the tax year to which the election would first apply.
Under the new rules, the due date to make the election is now on or before the last day of the 9th month after the end of the tax year. For example, a calendar-year-end FTE that wants to make the election for the 2024 tax year now has until September 30, 2025, to make the election. The change in election timing brings Michigan into conformity with most other states and offers the benefit of hindsight in deciding whether to make the election.
The Michigan FTE tax election remains a three-year irrevocable election because the bill made no changes to that aspect of the rules.
Expanded Safe Harbor
H.B. 5022 expands the safe harbor provisions related to estimated taxes to all FTEs that made the election, regardless of the prior year’s liability.
Previously, the penalty waiver was almost impossible if an FTE’s tax liability in the prior year exceeded $20,000. Now, penalties and interest for estimated tax underpayments will not be imposed for any taxpayer that paid in four equal installments either:
- 90% of the current year’s tax liability; or
- 100% of the previous tax year’s tax liability.
The bill also adds a safe harbor for estimated tax payments that were due before the election was made unless the Michigan Department of Treasury determines the deficiency is to the result of an intentional disregard of the law.
Related Tax Credit Updates
To reflect the changes described above, Michigan made corresponding adjustments to the disclosure and timing requirements for tax credits.
Before the law change, FTEs had to report to members their shares of taxes imposed and paid by the 15th day of the third month after the end of the tax year. Members were allowed to take credit in the tax year only for taxes the FTE had paid by that date.
Under the new rules, FTEs must now report to members their share of tax imposed and paid on or before the due date for filing the FTE tax return, including extensions. Members may now claim credits for amounts the FTE paid through the extended due date on their income tax returns for the applicable tax year.
BDO Insights
- FTEs that missed the election for tax year 2024, whether a first-time or renewal election, might want to reconsider making the election, especially given the added safe harbor provisions.
- It is unlikely that any estimated tax payments made by members will be applicable against FTE estimated tax payments, so double payments could be required while waiting for refunds on members’ returns.
- The new rules eliminate a payment-related “trap” in the Michigan FTE tax. Previously, an FTE could make payments against its FTE tax liability up until the original due date of the Michigan FTE return (e.g., March 31 for calendar-year FTEs). However, the owners’ FTE tax credits could be based only on payments made during the tax year and up through the 15th day of the third month after year-end (e.g., March 15 for calendar-year FTEs). If a calendar-year FTE made payments between March 15 and March 31, those payments could not be taken into account for the owners’ credits. Instead, those payments had to be taken into account for the owners’ credits calculated in the next tax year. That trap resulted in owners having FTE tax credits that fell short of the Michigan tax on their FTE flow-through income, which created a mismatch between when the Michigan taxable income was recognized and when the owner was allowed to take the credit.
- As long as there is some limitation on the amount of taxes an individual can deduct for federal income tax purposes under Internal Revenue Code Section 164(b)(6)(B), the option for an FTE to elect to pay the Michigan FTE tax should remain available. As such, it is possible that the FTE tax election and the related favorable timing under the new rules will provide benefits to FTE members past 2025.
Please visit BDO’s State & Local Tax Services page for more information on how BDO can help.