Michigan Issues Guidance on Withholding by Flow-Through Entities

The Michigan Department of Revenue has issued a release explaining the new withholding requirement that took effect January 1, 2012 for flow-through entities that have members, partners, or shareholders that are C corporations or—in some instances—other flow-through entities. A “C corporation” means any entity that is required to or has elected to file as a C corporation for federal income tax purposes. The requirement under the Income Tax Act to withhold on nonresident individuals and trusts that are members, partners, and shareholders of a flow-through entity has also changed. Business income is now apportioned using only the sales factor. In addition, fiscal year flow-through entities will file quarterly and annual withholding returns based on fiscal quarters and the fiscal year of the flow-through entity.

Flow-through entity defined. A flow-through entity is an entity that, for that tax year, is an S corporation, a general partnership, a limited partnership, a limited liability partnership, or a limited liability company, that is not taxed as a corporation for federal income tax purposes. A “member” of a flow-through entity is a shareholder of an S corporation, a partner of a general partnership, limited partnership, or limited liability partnership, or a member of a limited liability company.

Withholding on nonresident individual members:Every flow-through entity in Michigan must withhold on every member that is a nonresident individual or trust. This withholding is done at the individual income tax rate (4.35%) on the distributive share of taxable income reasonably expected to accrue, after allocation or apportionment, to the nonresident.

Withholding on corporate members:A flow-through entity with business activity in Michigan that reasonably expects to accrue more than $200,000 in apportioned or allocated business income for the tax year must withhold on the distributive share of each member that is a corporation at the corporate income tax rate (6%). Business income for a flow-through entity includes payments and items of income and expense that are attributable to business activity of the partnership or S corporation and separately reported to the members.

Withholding on flow-through entity members:A flow-through entity with business activity in Michigan that reasonably expects to accrue more than $200,000 in apportioned or allocated business income for the tax year must also withhold on the distributive share of each member that is a flow-through entity. Business income, for a flow-through entity, includes payments and items of income and expense that are attributable to business activity of the partnership or S corporation and separately reported to the members. If a flow-through entity (upper tier source flow-through entity) has members that are flow-through entities (lower tier members), then the upper tier source flow-through entity must withhold on the distributive share of the lower tier flow-through entities at the corporate income tax rate of 6%. However, the upper tier source flow-through entity may withhold at the individual income tax rate of 4.35%, instead of 6%, if it is able to identify the ultimate taxpayer in the lowest tier as a nonresident individual. Finally, the upper tier source flow-through entity is not required to withhold if it is able to identify the ultimate taxpayer in the lowest tier as a resident individual. A lower tier flow-through entity that has no business income sourced to Michigan, other than business income received from an upper tier flow-through entity, will not have to pay additional withholding and will be credited with any payments paid on its behalf by the upper tier source flow-through entity.

When flow-through withholding returns and payments are due. Flow-through withholding returns and payments are due to the Department on April 15, July 15, and October 15 of the flow-through entity's tax year and January 15 of the following year. If the flow-through entity is not a calendar year taxpayer then the flow-through entity will substitute the appropriate due dates in the flow-through entity's fiscal year that correspond to the to the due dates of a calendar year flow-through entity.

If the flow-through entity is required to withhold, then the flow-through entity must also file—in addition to the four quarterly returns—an annual reconciliation form that is due to the Department no later than February 28 for calendar year flow-through entities or the last day of the second month following the end of the flow-through entity's federal tax year for fiscal year flow-through entities.

How to report and pay flow-through withholding. A flow-through entity that is required to withhold must file a return and pay the withholding due on a quarterly basis. Quarterly flow-through withholding is reported and paid to the Department of Treasury using Form 4917 (Flow-Through Withholding Quarterly Return).These flow-through entities must also file a Form 4918 (Flow-Through Withholding Annual Reconciliation Form).