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Mi11. Will an Employee Stock Ownership Plan ("ESOP"), a tax exempt trust under federal laws, be liable for Michigan income tax under the Michigan Income Tax Act ("ITA"), 1967 P.A. 281, for it's share of flow-through income from a S corporation that is subject to MBT?
No. An ESOP that is a qualified retirement plan under section 401(a) of the Internal Revenue Code (26 U.S.C.A. 1 et seq) is exempt from federal income tax under section 501(a) of the code. If an S corporation establishes an ESOP for it's employees, the ESOP retirement trust fund will consist primarily or exclusively of stock from the S corporation. As long as the retirement plan maintains it's tax exempt status under §501, the trust's pro-rata or flow-through share of earnings from the S corporation are exempt from federal income tax.

The Michigan income tax is imposed on the taxable income of a person who is an individual, an estate, or a trust pursuant to section 51 of the ITA (MCL 206.51). Under section 201 of the ITA (MCL 206.201), a person who is exempt from federal income tax pursuant to the provisions of Internal Revenue Code shall be exempt [from the tax imposed by the ITA] except for the unrelated business income of the exempt person as determined under the Internal Revenue Code. Therefore, an ESOP that is exempt from federal income tax under §501 of the Internal Revenue Code and has no unrelated business income is exempt from Michigan income tax pursuant to MCL 206.201. Any unrelated business income of the ESOP that is subject to federal income tax would also be subject to the Michigan income tax imposed on trusts under MCL 206.51.

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