C. What adjustments are necessary on the member return for flow-through entity taxes that are refunded to the flow-through entity?

Electing flow-through entities that overpay the flow-through entity tax will receive a refund of that overpayment with interest as provided under the applicable provisions of the Revenue Act.⁵⁸ When received, that refund may be included in the federal taxable income of the flow-through entity. Consequently, the refund may also be included in the distributive share of its to members, which will later be used to determine Michigan taxable income for each member. Thus, to prevent the state taxation of certain refunds issued under the flow-through entity tax, PA 135 allows any direct or indirect allocated share of a refund of the Michigan flow-through entity tax to be deducted from the tax base of those members subject to tax under Part 1 of the Income Tax Act.⁵⁹ However, because tax refunds are not generally deductible under Part 2 of the Income Tax Act, there is consequently no similar deduction for corporations, insurance companies, or financial institutions that receive a direct or indirect allocated share of a Michigan flow-through entity tax refund. Flow-through entities are required to report to members any direct or indirect share of flow-through entity tax refunds included in income so that the members’ deductions, if applicable, can be reported accurately.

Example:
FTE made estimated payments of $100 entirely in Year 1. FTE’s tax liability as established on the Year 1 return filed in Year 2 was only $80. FTE accordingly receives a $20 refund when the return is processed in Year 2. That $20 refund was included in FTE’s Year 2 income and included in the Year 2 distributive share and, consequently, the adjusted gross income of individual members, A (75% owner) and B (25% owner). Members A and B subtract their allocable shares of the refund, which are $15 and $5, respectively.

⁵⁸MCL 205.30.
⁵⁹MCL 206.30(1)(q)(i); MCL 206.36(1)(b).