The Michigan Legislature joined several other states last year in helping eligible taxpayers offset the SALT Deduction Cap with the passage of H.B. 5376. Governor Gretchen Whitmer signed the bill into law in December.
So, what does this mean for Michigan businesses? If you have a flow-through entity and you paid more than $10,000 in state and local taxes, you may be able to deduct that excess despite the SALT Cap. This option helps lower the amount of federal tax you may owe. Here’s what you should know.
What Is the SALT Deduction Cap?
SALT stands for “state and local taxes”. That includes taxes paid to the county and municipal governments. It reflects both income taxes and property taxes. While it may apply to sales tax, filers must choose one or the other—sales tax or state income tax—when itemizing their deductions. Some taxes are exempt from the eligible deduction. A few examples include car inspection fees, gasoline tax, and property improvement fees.
The SALT Deduction Cap is part of the Tax Cuts and Jobs Act that Congress (TCJA) passed in 2017. In it, there’s a provision that limits or “caps” the amount of state and local tax that individuals can claim on their federal income tax filings. That limit is $10,000. So, filers may only reduce their taxable income with SALT payments of up to $10,000.
This is a temporary cap, expiring eight years after enactment. If no other tax code laws impacting this deduction are passed before 2025, taxpayers will again be able to claim 100 percent of their SALT deductions after the tax year 2025.
Salt Deduction Cap Example
You earned $75,000 in 2021. You paid $4,000 in property tax and $18,450 in Michigan income tax, for a total of $22,450 in SALT payments. The SALT Cap only allows you to deduct $10,000 of those payments. Assume your maximum income tax rate is 24.6 percent—the current average for that income in Michigan.
With a calculation of $10,000 times your 24.6 percent tax rate, you can reduce your 2021 tax burden by $2,460. Yet, without the cap, you could apply the full $22,450. Multiply that amount by your 24.6 percent tax rate and you see that you could lower your tax bill by $5,522.70 instead—an increased savings of $3,062.70.
Whom Does the SALT Deduction Cap Impact?
The SALT deduction cap applies to taxpayers who opt to itemize deductions rather than use the standard deduction. When those individuals or married couples pay more than $10,000 in taxes to their state and local governments, they cannot seek tax relief on their federal filings for any amount above the $10,000 cap. For married couples filing separately, the cap is $5,000 for each filer.
This provision impacts employed workers, as well as owners and members of pass-through entities. These types of business entities don’t pay corporate income tax. Instead, their owners and members report the profit they realize from the companies as taxable income when they file their annual individual income tax forms. Examples of flow-through or pass-through entities are S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships. Publicly traded partnerships and disregarded entities, such as a single-member LLC, are not pass-through entities. The Cap also impacts certain trusts
What Is the Michigan SALT Deduction Workaround?
Before the TCJA, there was no limit on the SALT deduction. As an individual filer who itemized, you could claim the entire amount you paid in taxes to your state and local governments as a federal tax deduction. But with the cap, if you pay high state and local taxes, your tax burden has increased. Therefore, various state legislators have passed laws to help offset this effect. They’re called “workarounds” because they are designed to circumvent or bypass the existing federal tax code to implement a temporary fix.
In Michigan, the SALT Deduction Workaround lets you pay Michigan taxes on your flow-through business on the entity level, instead of through your personal income tax filing. You can then apply for a refundable credit on your personal tax return for the taxes you paid Michigan on the entity level. This workaround allows you to deduct your full payment since the IRS does not cap entity-level SALT payments.
How To Apply the Michigan SALT Deduction Cap Workaround
Eligible business owners must elect to be subject to the flow-through entity tax by making their payment through the Michigan Treasury Online—MTO—system. This election then applies automatically for the following tax years 2022 and 2023. This election is irrevocable.
The Michigan Department of Treasury advised eligible pass-through entities to make their initial election payment by December 31, 2021. The Department has promised to release further guidance on how to take advantage of the workaround soon.
What Else Michigan Pass-Through Business Owners and Members Should Know
If you believe that the Michigan SALT Deduction Cap workaround can benefit you, be sure to take the necessary steps in time. Here are some keynotes.
- The deadline to take advantage of the workaround is April 15, 2022.
- The workaround election is binding through 2024.
- The deadline for the following years is on March 15.
- The current individual income tax rate for Michigan filers is 4.25 percent.
- You must submit payments online through the MTO.
- Businesses that must pay taxes related to a Chapter 13 filing are not eligible.
- If you’ve made estimated projected tax payments in 2021, an entity-level tax payment now may lead to a temporary double payment.
- Extra reporting costs may outweigh the tax benefit of the workaround, especially for filers under the 32 percent federal income tax bracket.
The CPA Nerds can help you understand the Michigan SALT Cap workaround and whether it’s the best option for you and your pass-through entity. Contact us today for further information.