Keeping up with tax law changes year-round is essential for both businesses and individuals. An announcement from the Internal Revenue Service (“IRS”) could mean an opportunity to take advantage of a new deduction or credit, a disadvantageous provision to be aware of, or a proposed tax law change that may be enacted in the future. In this article, we will highlight tax law changes that will impact 2022 tax compliance.
Michigan Flow-Through Entity Tax Election
Enacted on December 20, 2021, owners of Michigan pass-through entities (e.g., LLCs and S Corporations) now have a workaround to the state and local tax (“SALT”) deduction limitation enacted by the Tax Cuts and Jobs Act (“TCJA”), contingent on the provision’s existence.
What it means: If a pass-through entity’s owners choose to make the FTE tax election, the business will pay an entity-level tax equal to the net income it will flow through to its owners multiplied by the Michigan individual income tax rate of 4.25%, which can be deducted by the business on its tax return for the year it was paid. The entity owner will be given a credit on their Michigan individual income tax return for the portion of the FTE tax payment allocable to him or her (based on his or her ownership percentage).
What is the Benefit?
As previously alluded to, the TCJA enacted a SALT deduction cap which has proved to be a detrimental provision for individual income taxpayers who itemize deductions on Sch A and incur more than $10K total in state and local income, sales, real estate, and personal property taxes. SALT payments incurred during a calendar year exceeding the $10K cap are nondeductible in the current year and do not carry forward. The FTE tax election acts as a workaround to the TCJA SALT deduction limitation because it allows the owner of a flow-through entity to deduct the MI individual income taxes imposed on their allocable pass-through income at the entity level, thereby moving the deduction from Sch A to Sch E where it will not be limited.
For example, Company A generated $1M of net pass-through income in 2021 and is owned 50% by Tyler Durden. 50% of the $1M is allocable to Tyler, so $500K will flow through to his individual income tax return. He will incur $21,250 in MI individual income taxes which can be deducted on his 2022 Sch A (remember, tax payments are deductible for the tax year in which they were paid), and in addition, he paid $5K in real estate taxes. His SALT deduction is limited to $10K, so $16,250 is permanently non-deductible. His effective tax rate is 37%, so his foregone tax savings is $6,013. If a timely FTE tax election was made in 2021, the $21,250 in MI individual income taxes would have been deducted at the entity level and thereby moved off of his Sch A; allowing him to utilize his otherwise nondeductible SALT payments.
Making the FTE tax election is even more beneficial for pass-through owners who take the standard deduction on their federal individual income tax return, as the MI individual income taxes imposed on their allocable pass-through income can now be deducted in addition to taking the standard deduction rather than be considered as an itemized deduction that is forgone by virtue of taking the greater standard deduction by comparison.
How it Works:
- To make a timely election for a taxable year, it must be made by the 15th day of the third month of that taxable year.
- The MI annual FTE tax return must be filed by the last day of the third month following the end of the entity’s tax year.
- Once the election is made, it’s irrevocable for three years (the tax year the election was made and the following two tax years).
- All payments must be made through the Michigan Treasury Online portal.
- Flow-through entities that make this election must estimate their annual MI tax liability.
- If an entity’s liability is reasonably expected to exceed $800, it must make quarterly tax payments.
Are you interested in making the FTE tax election for your business? Connect with our tax professionals here.
Mileage Reimbursement Rate Increase
The standard mileage reimbursement rate will rise in 2022. For the first half of 2022, the standard mileage reimbursement rate increases 2.5 cents per mile from 2021, for an adjusted rate of 58.5 cents per mile driven for business use. The IRS recently published a news release stating that beginning July 1, 2022, taxpayers will see an additional increase in the standard mileage reimbursement rate due to surging gas prices. Business miles driven from July to December 2022 will be reimbursable at 62.5 cents per mile, representing an additional 4-cent bump. Keep in mind that business miles do not include your regular commute to your workplace.
The reimbursement rate for medical-related travel or moving purposes for qualified active-duty members of any branch of the Armed Forces also sees an increase for 2022, resulting in a new rate of 18 cents per mile which is up 2 cents from last year.
Taxpayers now have the option of calculating the actual costs of using their vehicle as opposed to taking the standard mileage approach even if the standard mileage approach was used in a previous year. To use the standard mileage rate, taxpayers must opt to use it in the 1st year the vehicle is available for business purposes. Then, they are allowed to choose either the standard mileage rate or take actual expenses in subsequent years. For leased vehicles, if the standard mileage rate is chosen it must be applied consistently throughout the entire lease period.
Enhanced Business Meal Deduction
While there is no change to the business meal deduction for business owners and self-employed individuals from 2021 to 2022, it’s important to note that the enhanced business meal deduction increased the deductible percentage for qualified meal expenditures from 50% to 100% ends after the 2022 tax year. The pre-Consolidated Appropriations Act (“CAA”) business meal deduction rules will resume for the 2023 tax year and beyond until further tax reform is enacted.
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