B. What adjustments are necessary on the member return for taxes paid by the flow-through entity?

PA 135 amended Part 1⁵⁴ and Part 2⁵⁵ of the Income Tax Act to require certain members to add back their direct or indirect allocable share of taxes paid by a flow-through entity in the computation of Michigan taxable income. Except for nonresident fiduciaries, financial institutions, and insurance companies, which do not have a required addition due to the computation of their respective tax bases,⁵⁶  this addition is designed to reverse the state tax impact of the federal tax deduction reported by the flow-through entity for the payment of the flow-through entity tax. For this reason, the flow-through entity must report to each member their allocable share of taxes paid under the flow-through entity tax that were deducted on the flow-through entity’s return for that tax year. Based on this addition, the member is eligible to claim the full refundable credit for the share of tax paid by the flow-through entity.

Example:
FTE elects to pay the flow-through entity tax in Year 3. It reports to Individual A a distributive share income of $96 on the Federal Schedule K-1, which includes a deduction of $4 in Michigan flow-through entity taxes paid. FTE separately reports to Individual A the $4 of flow-through entity taxes it deducted federally and a $4 credit for the taxes levied for Year 3 and paid by the due date of that return. Individual A reports the $96 distributive share in adjusted gross income. In computing Individual A’s Michigan individual income tax return for that same year, Individual A must add back the $4 of Michigan flow-through entity taxes deducted by the flow-through entity, and will be eligible to claim the $4 credit from FTE. With these adjustments, the member owes no additional tax on the Michigan return.

Individual A's Michigan Return
Adjusted Gross Income: 96
Addition for taxes deducted by FTE: 4
Michigan Taxable Income⁵⁷: 100
Michigan tax due @ 4.25% (rounded): 4
Credit from FTE: ($4)
Total amount due from Member: $0

⁵⁴MCL 206.30(1)(b).
⁵⁵MCL 206.623(2)(b).
⁵⁶For example, the tax base of a financial institution subject to the franchise tax under Part 2 of the Income Tax Act is based on total equity capital. MCL 206.255. A financial institution’s tax base will not be impacted by a flow-through entity’s deduction of Michigan flow-through entity taxes paid at the federal level such that an addition is not required.
⁵⁷Personal exemptions have been ignored for purposes of the examples in this Notice.