Restoring the Benefits of SALT

Workaround clears the road for select Michigan business owners.

During the final weeks of 2021, Michigan joined a growing number of states in adopting State And Local Tax (SALT) parity reforms. Governor Whitmer signed a bill into law December 20 that creates an election for owners of pass-through entities with Michigan-sourced income to pay state and local taxes at the entity level instead of at the individual level.

The passage of this bill is in response to the “SALT cap” imposed by the Tax Cuts and Jobs Act of 2017 (TCJA), which limited the federal deduction for payment of state and local taxes to $10,000 for individual taxpayers itemizing their deductions. Prior to TCJA, taxpayers itemizing their deductions could deduct an unlimited amount of state and local against their federally taxable income. The new election is intended to provide a workaround to restore the SALT deduction to Michigan’s pass-through entities. It will remain available as long as the individual deduction is limited by a SALT cap. If no action is taken by Congress in the interim, the SALT cap will expire at the end of 2025.

The bill is designed to benefit the nearly 240,000 resident owners of pass-through entities that have been impacted by the SALT deduction limitation. As the name implies, a pass-through (or flow-through) entity is a business entity that passes its income on to the owners or investors of the business. This would include entities such as S-corporations, partnerships, and limited liability companies. The election is not available to publicly traded partnerships, financial institutions, or disregarded entities.

Instead of the individual paying state income tax, the entity elects to pay an alternative tax called a “flow-through entity tax” at the same rate as Michigan’s income tax (4.25%). Those entity taxes are deductible for federal income tax purposes without regard to the $10,000 limitation imposed on individual taxpayers. Owners will then be able to claim a tax credit in an amount equal to their allocated share of the tax paid by the pass-through entity. This chain of transactions forms the workaround to avoid the federal $10,000 limit on individual SALT deductions. This bill is expected to save Michigan pass-through entity owners roughly $200 million annually in federal taxes without reducing tax collections to the state. In that regard, it is beneficial for both Michigan and its business owners.

The election to pay the flow-through entity tax can still be made retroactively for the 2021 tax year for certain taxpayers. Pass-through entities intending to make an election for 2021 must do so by April 15, 2022. This initial election is irrevocable for the two subsequent tax years and a separate election will need to be made for any future years. Therefore, if an election is made for tax year 2021, the election must remain in place for tax years 2022 and 2023.

For pass-through entities using a cash basis method, the ability to claim a deduction for tax year 2021 has passed as it was only available for an extremely narrow window at year-end. In order to have claimed a deduction for federal tax purposes, the 2021 payment of the flow-through entity tax needed to be received by December 31. However, for pass-through entities using an accrual basis method, there may still be an opportunity to make the election and take advantage of the deduction for the 2021 tax year. If you are considering taking advantage of this benefit for tax year 2022, timing is still critical as that election must be made by March 15, 2022 for certain taxpayers.

A detailed analysis on the timing and whether this election will be beneficial to the entity, owner, and non-resident owners is prudent prior to moving forward. To explore the potential benefits for your specific situation for tax year 2021 and beyond, we recommend consulting with your tax advisor. Additional details are still being finalized and the Michigan Department of Treasury is expected to publish additional guidance on the flow-through entity tax in early 2022.