What Is Flow Through Entity Tax Michigan?

Flow-through entities are common business structures where income, losses, deductions, and credits pass directly to the owners, who then report these items on their personal tax returns. This means the business itself typically does not pay income tax. While this direct pass-through of income for taxation generally applies, Michigan has implemented an elective entity-level tax that allows certain flow-through entities to pay income tax at the business level.

Michigan’s Flow-Through Entity Tax Overview

Michigan’s Flow-Through Entity (FTE) tax, also known as the Pass-Through Entity (PTE) tax, became effective for tax years beginning on or after January 1, 2021. This tax was introduced to provide a workaround for the federal limitation on the deduction of state and local taxes (SALT cap) for individual taxpayers, which caps the deduction at $10,000. By allowing the entity to pay the tax, the business can deduct it at the entity level, potentially offering a federal tax benefit to the owners.

For this tax, a flow-through entity in Michigan is defined as an S corporation or a partnership for federal income tax purposes. This includes limited liability companies (LLCs) that elect to be taxed as partnerships or S corporations. The tax is levied on electing entities with business activity within Michigan.

The Michigan FTE tax is an elective tax. This election is binding for the year it is made and the subsequent two tax years, establishing a three-year irrevocable period.

Calculating the Taxable Income

The Michigan FTE tax applies to the positive business income tax base allocated or apportioned to Michigan. This tax base generally aligns with federal taxable income. For S corporations, it begins with their federal taxable income, while partnerships use their ordinary business income.

Specific Michigan adjustments are applied to this federal income base to determine the Michigan flow-through entity taxable income. Additions may include guaranteed payments to individual members for services rendered, certain interest income, or tax refunds previously deducted. Subtractions can include capital gains or losses, passive activity losses, and charitable contributions, as specified in Michigan tax law, MCL 206.801.

The tax is levied only on the portion of the business income tax base attributable to direct members who are individuals, fiduciaries, or other flow-through entities. Income attributable to corporate members, insurance companies, or financial institutions is excluded.

Electing and Paying the Tax

Qualifying entities elect into the Michigan Flow-Through Entity (FTE) tax by submitting a payment through Michigan Treasury Online (MTO). For tax years beginning on or after January 1, 2024, the election deadline is the last day of the ninth month after the end of the tax year. For example, a calendar-year entity has until September 30 of the following year to make the election for the prior tax year.

The tax rate applied to the Michigan flow-through entity taxable income is generally the same as the individual income tax rate. For tax years beginning after 2022, this rate is 4.25%. For 2023, the rate was temporarily reduced to 4.05%, reverting to 4.25% for tax years beginning in 2024.

Entities electing to pay the FTE tax must make estimated tax payments if their annual tax liability exceeds $800. For calendar year filers, these payments are generally due in equal installments on April 15, June 15, September 15, and January 15 of the following year. Payments can be made electronically through Michigan Treasury Online or by check.

Reporting Requirements and Owner Impact

Electing flow-through entities must file an annual return, Michigan Form 5772, to report the FTE tax. This return is generally due by March 31 for calendar year filers, or the last day of the third month following the entity’s fiscal year-end. An automatic six-month extension is available, extending the due date to September 30 for calendar year filers.

The tax paid at the entity level translates into a refundable credit for owners on their individual Michigan income tax returns, ensuring income is taxed only once. The entity communicates the amount of this credit to its members, typically through information provided on Schedule K-1. Owners then claim this credit on their personal Michigan income tax return, Form MI-1040.

For tax years beginning on or after January 1, 2024, an owner’s share of the tax paid by the FTE is creditable on the owner’s return if the payment is made before the due date of the entity’s annual return, including extensions. This provides flexibility for payment timing to qualify for the credit.