A. What is the refundable credit available to members of an electing flow-through entity?

General Information About the Credit

PA 135 amends Part 1 and Part 2 of the Income Tax Act to create a refundable credit for certain members of an electing flow-through entity, including individuals, fiduciaries, corporations, insurance companies, and financial institutions. The credit is comprised of three components that must be reported each year to members of a flow-through entity:

1. The member’s share of the Michigan flow-through entity taxes imposed on the flow-through entity for the tax year that ends with or within the member’s same tax year and paid by the fifteenth day of the third month after the end of the flow-through entity’s tax year;
2. The member’s share of any Michigan flow-through entity taxes imposed in a prior year that are paid in the flow-through entity’s current tax year that ends with or within that member’s same tax year, excluding any amount reported under 1 for the previous tax year; and
3. The member’s share of any flow-through entity taxes paid that are allocated to the reporting flow-through entity by other flow-through entities with tax years ending on or within the reporting flow-through entity’s tax year.

Based on these provisions, the amount eligible to be claimed for a credit is limited in two critical respects. First, the refundable credit is limited to the member's allocable share of tax imposed on the flow-through entity under the flow-through entity tax. As such, the credit is limited to the tax levied on the business income tax base of the flow-through entity, after allocation and apportionment to Michigan and as otherwise determined under the relevant provisions of the flow-through entity tax. Overpayments of the flow-through entity tax, including any overpayments of the quarterly estimated tax, will therefore not generate larger credits for members and will instead be refunded to the flow-through entity that made overpayments. Likewise, any portion of a payment from a flow-through entity that is applicable to penalty or interest is not eligible to be claimed as a credit.

Example:
FTE made timely estimated payments of $1,000, but FTE’s annual flow-through entity tax liability is only $900. FTE will therefore claim a $100 refund on its annual return, which will be issued to the FTE upon the processing of that return. The credit available to members of the FTE will be limited to their allocable share of the $900 tax levied on the FTE.

Second, the refundable credit is limited to the amount of tax paid by the fifteenth day of the third month after the end of the tax year. As a result, any payment submitted after that date is not eligible for a credit in the same tax year that the flow-through entity’s members report the associated income. Those payments, however, may be eligible for a credit in the members’ following tax year.

Example:
FTE is a calendar year taxpayer and timely paid $1,000 in quarterly estimated tax payments for Year 1. FTE also requested and received an extension of time to file the Year 1 annual return. When filing the Year 1 return on September 30, Year 2, FTE determined that additional tax was owed and paid an additional $500 in tax, plus $100 in combined penalty and interest. For members of FTE, the Year 1 credit is based on each member’s share of the $1,000 in taxes paid as of March 15, Year 2. Even though the additional $500 tax payment was paid toward FTE’s Year 1 liability and by the extended due date of that return, that payment is not eligible for a Year 1 credit. Instead, that payment may be claimed as a credit by members in Year 2. The $100 payment attributable to penalty and interest is not eligible to be claimed for the credit in any tax year.

The FTE should account for these limitations when reporting each member’s share of flow-through entity taxes paid. And, to the extent applicable, each of the various components of the credit must be reported separately to each member rather than as a lump sum amount. Most individual members of the flow-through entity may combine those amounts as reported to them and claim a credit on their returns for the applicable tax year; however, detailed records may be required upon audit.

Credit Adjustment for Trusts and Estates

The credit is generally available for trusts and estates that are direct or indirect members of an electing flow-through entity. While the credit for these taxpayers is subject to the same limitations above, additional adjustments are required for resident and nonresident fiduciaries (i.e., estates and trusts). As a general matter, fiduciaries are typically subject to tax only on the Michigan portion of taxable income retained by the fiduciary. To ensure the refundable credit matches the income ultimately subject to tax at the fiduciary level, any credit claimed by a fiduciary must be prorated by the ratio of flow-through entity income retained to total flow-through entity income included in distributable net income of the fiduciary. And, because nonresident fiduciaries are not required to add back flow-through entity taxes in the computation of their tax base, those members are further limited to a 95.75% credit before that proration. Thus, the amount of the credit claimed on an annual return for a fiduciary is subject to the following two-step calculation:

1. For nonresident fiduciaries only, first multiply the credit reported by the flow-through entity by 95.75%.
2. For resident and nonresident fiduciaries, multiply the applicable credit amount (for residents, the amount reported by the flow-through entity; for nonresidents, the result of step 1) by the ratio of flow-through entity income retained by the fiduciary to total flow-through entity income included in distributable net income of the fiduciary. The result from this step is the amount of refundable credit that the fiduciary is eligible to claim on its annual return.

Example:
Nonresident Trust (NT) receives a distributive share of income of $24,150 from electing flow-through entity (FTE), of which $19,150 is apportioned to, and taxable in, Michigan. Based on the tax levied on and paid by it, FTE reports that NT has an allocated credit for flow-through entity taxes equal to $850. NT retains 75% of its income, including income earned as a distributive share, and distributes the remaining 25% to beneficiaries.

Nonresident Trust Calculation
MI Flow-Through Income Retained ($19,150 * 75%): 14,363
Michigan Tax @ 4.25% (rounded): 610
Total Credit Reported by from FTE: 850
Step 1: Adjust for 95.75% of total: 813
Step 2: Adjust for 75% income retained:  610
Adjusted credit from FTE: (610)
Total Amount Due: 0

A fiduciary may also have reporting requirements under PA 135. If income is passed through to beneficiaries and the fiduciary receives a refundable credit based on the flow-through entity tax, the fiduciary must report to beneficiaries, along with income and any other required information and by the due date of the fiduciary’s annual return, each beneficiary’s allocable share of the credit distributed. The credit distributed is determined by multiplying the amount of the credit reported to the fiduciary by the ratio of flow-through entity income distributed to the beneficiaries to total flow-through entity income included in the distributable net income of the fiduciary.

Credit for Members Subject to Corporate Income Tax

The credit is technically available for members subject to tax under Part 2 of the Income Tax Act (corporations, insurance companies, and financial institutions)⁵¹  even though the flow-through entity tax is not levied on shares of income attributed to those members.⁵² The credit remains necessary, however, because in certain tiered structures, an electing entity may not know the identity of its indirect members, yet is required to pay tax attributed to any direct member that is another flow-through entity. In these cases, it is possible that the flow-through entity tax is paid on income attributable to an indirect member that is a corporation, insurance company, or financial institution. To ensure that tax is not paid at both the entity and member levels, the corporation, insurance company, or financial institution may therefore claim the refundable credit on their respective Corporate Income Tax return. The credit is available only to accommodate these unique circumstances and flow-through entities may not elect to pay tax for the purpose of generating a credit for direct members subject to tax under Part 2 of the Income Tax Act. Thus, an electing flow-through entity must exclude from its business income tax base any income attributable to its direct members that are subject to the tax under Part 2 of the Income Tax Act.⁵³

⁵⁰MCL 206.254(5) (excluding all interest, including “bonus” interest); MCL 206.675(3).
⁵¹MCL 206.675.
⁵²MCL206.815(5).
⁵³Id.