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Editorial 7 MIN READ

Michigan's 2023 tax tweaks: the rate-drop that didn't touch the C-corp

The individual rate fell to 4.05%, the corporate rate stayed at 6.00%, and the FTE election now carries a built-in mismatch

The Editors
Staff, Incorporator.org
7 min read Updated
Contents 6 sections
  1. What the 6.00% corporate rate actually covers
  2. The 4.05% individual rate and why it happened on autopilot
  3. The Flow-Through Entity election and the rate mismatch
  4. The math, walked through
  5. Who should actually consider this
  6. Sources

ichigan's corporate income tax did not move in 2023. The headline-grabbing number that did move, from 4.25% to 4.05%, was the individual rate, and it moved because of a formula rather than a legislative vote. For a founder choosing between a Michigan C-corp, an LLC taxed as a partnership, and an S-corporation, the gap between those two worlds just widened in a way that matters for the Flow-Through Entity election.

The corporate rate is set by MCL 206.623 at 6.00% on the Michigan corporate-income-tax base, and no bill this session disturbed it. The House Fiscal Agency's revenue outlook treats that 6.00% as the operating assumption through the FY 2025 projection. What shifted, and what is worth understanding before March filings, is the interaction between the individual rate, the FTE election, and the SALT-cap workaround that Public Act 135 of 2021 put on the books.

What the 6.00% corporate rate actually covers

Michigan's Corporate Income Tax (MCIT) under Part 2 of the Income Tax Act applies to C-corporations and to entities federally taxed as C-corporations. The base is federal taxable income with Michigan adjustments, apportioned by a single-sales-factor formula, and the liability is 6.00% of that base under MCL 206.623(1). Financial institutions and insurance companies sit outside the MCIT in their own regimes; the general rule that matters for most operating companies is the flat 6.00% on apportioned business income.

MCL 206.625 continues the successor-credit regime that lets taxpayers with certificated SBT credits, brownfield credits, MEGA credits, and historic preservation credits elect to remain under the old Michigan Business Tax to exhaust them. That is the structural reason some Michigan-based manufacturers still file under MBT rather than MCIT in 2023. For a new formation with no such credits, the 6.00% MCIT is the only rate that applies, and it has been flat since the CIT replaced the MBT for general taxpayers effective January 1, 2012.

The 4.05% individual rate and why it happened on autopilot

Michigan's individual income tax rate dropped from 4.25% to 4.05% for tax year 2023. The cut was automatic, not legislated this year, and the mechanism is MCL 206.51(1)(c). The statute requires the Department of Treasury to compare the growth of general-fund revenue to the rate of inflation over a prescribed look-back period; when general-fund receipts exceed the inflation-adjusted baseline by a defined margin, a corresponding reduction to the individual rate is triggered for the following tax year.

Treasury certified in March 2023 that the trigger had fired based on FY 2022 general-fund performance, and the rate for tax year 2023 moved to 4.05% as a result. There is ongoing litigation and political argument about whether the rate cut is a one-year event or a permanent floor, a question that turns on the reading of "current rate" in MCL 206.51. The Attorney General's interpretation treats the cut as a single-year reduction that reverts absent another trigger; that reading is being contested. For 2023 returns, in any event, the rate is 4.05%.

Twenty basis points sounds small. On a sole proprietor netting $400,000 of Michigan-source business income, it is $800. On a larger professional-services LLC it is paid by partners individually, and its interaction with the FTE election is where the planning gets interesting.

The Flow-Through Entity election and the rate mismatch

Public Act 135 of 2021 gave Michigan one of the cleaner versions of a state SALT-cap workaround. Codified at MCL 206.813, the Flow-Through Entity (FTE) tax is a state-level income tax imposed on the entity itself (the LLC, the partnership, the S-corp), elected annually, and deductible for federal purposes as a business expense at the entity level. The federal $10,000 state-and-local-tax cap under IRC § 164(b)(6) does not apply to taxes paid by the entity; it applies to individuals. By paying the tax at the entity level, Michigan flow-through owners get the federal deduction their neighbors with W-2 income cannot.

The IRS blessed this architecture in Notice 2020-75, which said the Service will respect pass-through-entity-level state taxes as specified income-tax payments by the entity. The Michigan election is retroactive to tax years beginning on or after January 1, 2021, and is made annually through MTO on the FTE return.

Here is where 2023 introduced a wrinkle. The FTE tax rate is pegged by MCL 206.815 to the individual income tax rate "set forth in" MCL 206.51(1)(b), which is the 4.25% historical rate. The FTE statute references the fixed 4.25% figure in that subsection rather than floating with whatever the current individual rate happens to be under the MCL 206.51(1)(c) trigger. So for tax year 2023, the FTE tax is imposed at 4.25% on the Michigan-source income attributable to members, while those same members owe individual Michigan tax at 4.05% on their distributive-share income.

The members get a refundable credit on their Michigan individual return for their share of the FTE tax paid by the entity. If the FTE rate (4.25%) exceeds the individual rate (4.05%), the credit is still refundable, so no state tax is overpaid in net. The gap of 20 basis points is, in effect, parked at the entity and returned to the owner. What the owner keeps is the federal deduction on the full 4.25% paid at the entity level, not just on the 4.05% that would have been the underlying individual liability.

The math, walked through

Assume a Michigan-sourced S-corporation with $1,000,000 of apportioned business income allocable to a single 37%-bracket federal individual owner.

Without the FTE election, the owner pays $40,500 of Michigan individual tax at 4.05% on the $1,000,000 of pass-through income. That $40,500 is a state income tax for the individual. It is capped at $10,000 on the owner's federal Schedule A by IRC § 164(b)(6), and the cap is almost certainly already consumed by property taxes and other state income taxes before this line is reached. Net federal deduction attributable to the Michigan tax: effectively zero.

With the FTE election, the entity pays $42,500 of Michigan FTE tax at 4.25% on the same $1,000,000. That $42,500 is deducted at the entity level, flowing through as a $42,500 reduction in federal pass-through income. At a 37% federal marginal rate, the federal tax savings is roughly $15,725. The owner then claims a $42,500 refundable credit on the Michigan individual return against what would have been a $40,500 Michigan liability, receiving a $2,000 refund for the overpayment. Net Michigan cost: $40,500, the same as without the election. Net federal benefit: roughly $15,725.

The election remains, for all but the smallest pass-throughs, a substantial win. The 2023 rate drop narrows the theoretical advantage (because the individual-level rate the credit offsets is lower) without changing the qualitative answer. For professional-services firms, single-family real-estate LLCs with positive net income, and closely held S-corporations with Michigan-source operating income, the FTE election continues to clear the administrative cost of filing it.

Who should actually consider this

A Michigan C-corp founder sees none of this. The 6.00% MCIT rate is the rate, the FTE election does not apply, and the SALT cap is an owner-level problem rather than an entity-level one. The decision for a C-corp forming this year is whether Michigan is the right state of formation at all, and that is a separate question answered mostly by where the company operates and raises capital.

A Michigan LLC or S-corp with operating income above what the owner draws as reasonable compensation should run the FTE math every year, elect if the number is material, and file the return by the statutory deadline. The election is annual and not sticky; missing the window forfeits the year. For 2023, the rate-mismatch wrinkle is a reason to run the arithmetic rather than rely on a prior-year calculation.

A Michigan pass-through considering relocation to a no-income-tax state should note that the FTE election only resolves the federal SALT cap. It does not reduce the Michigan liability itself. The federal deduction is real, and it closes most of the apparent gap that motivates those moves.

The rate-cut litigation worth watching is the question of whether 4.05% sticks. If the Attorney General's reading prevails, 2024 returns to 4.25% and the FTE mismatch closes. If the plaintiffs prevail and the reduction becomes a ratchet, the mismatch persists and the FTE election's value to owners grows at the margin. Either way, the 6.00% corporate rate is not on the table.

Sources

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