In mid-summer 2021 Michigan Governor Gretchen Whitmer vetoed a bill that would have provided a workaround to the current cap on the deduction for state income taxes that business owners face on pass-through income. The bill would have given a pass-through entity the option of being assessed state income taxes at the entity level instead of the individual level.
Impact to business owners
The veto is important as individuals are limited on the amount of taxes they can deduct in calculating their federal taxes. As state taxes imposed directly on a business entity are deductible for determining federal taxable income, the result is less income passing to the owner’s tax return.
When the Tax Cuts & Jobs Act was enacted creating the limitation, states with highest tax rates began looking for a way to get around the cap. When calculating a state’s tax base, state taxes are added back; making it neutral to the state’s tax revenue. Several states have now enacted legislation that allows a pass-through business entity to elect whether the state tax liability will be assessed at the entity level versus the owner level.
So the question at hand is why Gov. Whitmer would veto a bill that is tax neutral to the State of Michigan. Gov. Whitmer stated that it would be too costly to administer this type of change because there is still the cost of updating the software that processes returns and other updates that would need to be made to implement the change.
As part of Michigan’s budget S.B. 82, the Michigan Department of Treasury was allocated a $4.6 million cash injection for Flow-Through Entity Tax Implementation leading the way for another shot at getting a workaround passed.
UPDATE: On October 14, House Bill 5376 (2021), the workaround to the federal limitation on the deduction for state income taxes on business taxes, was passed by the House. The bill now moves on to the Senate. We will keep you advised on any additional updates.