2003 Legislation Creates Withholding Obligation

Reporting Obligations Clarified

Quarterly Tax Remittance Required

Income Available for Distribution Clarified

Tiered Entity Exception Discussed

A recent Michigan Department of Treasury bulletin summarizes provisions of 2003 legislation that amended the Michigan Income Tax Act to impose income tax withholding and reporting requirements on flow-through entities with non-resident members.

RAB 2003-4 describes the general income tax withholding and reporting requirements of flow-through entities with non-resident members and business activity in Michigan, clarifies the term “income available for distribution,” explains the effective date and procedural mechanics of implementing this new requirement, and also discusses a specific exemption to the tiered-entity withholding requirements.

Because of the risk of penalties for non-compliance with these new provisions that are in effect for 2003 and 2004 estimated tax purposes, it is important taxpayers and tax advisors understand the application of these new provisions.

2003 Legislation Creates Withholding Obligation

Effective October 1, 2003 public acts 22, 45, 47, 48, 50 and 51 of 2003 impose income tax withholding and reporting requirements on flow-through entities with non-resident members in the same general manner used by employers to report and remit withholding taxes on wages.

As set forth in Mich. Comp. Laws Sec. 206.12, and amended by P.A. 45, the term "flow-through entity" means an S corporation, partnership, limited partnership, limited liability partnership or limited liability company. The term specifically excludes publicly traded partnerships established under section I.R.C. Sec. 7704. This exclusion applies to publicly traded partnerships treated as corporations as well as those treated as partnerships under I.R.C. Sec. 7704(c).

The bulletin specifies that “disregarded activities” such as QSUBs and single member LLCs (SMLLCs) are also subject to the withholding requirements including SMLLCs treated as sole proprietorships.

Reporting Obligations Clarified

Section 206.365, as amended by P.A. 47, sets forth specific reporting requirements with respect to flow-through entities incurring withholding tax obligations. As specified in the bulletin, each flow-through entity must furnish each non-resident member with a statement reflecting the tentative or estimated share of taxable income available for distribution upon which withholding was based and the actual amount of taxes deducted or withheld. This statement must be provided to the non-resident member on or before January 31 of the succeeding year on a form prescribed by the department.

Certain exceptions to the reporting requirements apply to composite filers. In addition, the flow-through entity must furnish the department with a duplicate of the statement furnished to the non-resident member no later than February 28 of the succeeding year with an annual reconciliation return, Form 165 Sales, Use, and Withholding (SUW) Taxes Annual Return.

Each non-resident member is required to provide the flow-through entity with information on which to base an accurate determination of withholding tax by completing a Form W-4, Employees Michigan Withholding Exemption Certificate. This form must be re-filed with the flow-through entity only if the number of dependency exemptions of the member changes.

As pointed out in the bulletin, in many cases, the entity level withholding required under the new law will eliminate quarterly estimated filing and payment requirements historically imposed at the individual level on nonresidents.

Quarterly Tax Remittance Required

As amended, the statute requires quarterly remittance of withholding taxes by flow-through entities. The quarterly remittance must be calculated using Form 3862, Monthly or Quarterly Sales and Use Tax Worksheet, and the payment must be remitted using the payment voucher, Form 160, Combined Return for Michigan Taxes. Due date of the remittance is the 15th day of the month following the quarter's end (i.e., generally April 15, July 15, October 15 of the taxable year, and January 15 of the succeeding year).

If the flow-through entity is also liable for employee withholding or sales and use taxes, the remittance of withholding taxes from the non-residents' share of income available for distribution must be included with the same remittance device being used for employee withholding or sales and uses taxes.

The first withholding payment due for all affected flow-through entities will be January 15, 2004, covering the quarter ending December 31, 2003. Flow-through entities not previously registered for withholding taxes with the department must complete and file Form 518, Registration for Michigan Taxes, prior to remittance of any payments.

A flow-through entity which paid in the immediately preceding calendar year an average of $40,000 or more per month in income tax withholding on the combined share of income available for distribution and employee wages must deposit the Michigan tax withheld at the same time and in the same manner as deposits of federal withholding taxes. Generally this will require an electronic funds transfer in accordance with the time frames provided in the I.R.C. and may be as soon as the day after "withholding."

Flow-through entity withholding will be deemed to occur on the last day of the quarter, and remittance of the withholding for the affected accelerated filers must be made by electronic funds transfer at any subsequent time, but not later than the 15th day of the month following the end of the quarter.

Income Available for Distribution Clarified

The bulletin provides the share of taxable income available for distribution to a non-resident member is the distributive share of the net profits of the flow-through entity that will be included at year-end in the adjusted gross income of the nonresident individual's annual federal income tax return, and reported on the member's federal K-1 form. If the flow-through entity is unable to make an accurate determination of the member's share of taxable income available for distribution using financial information from the immediately preceding three months, the department will allow withholding calculations based on one of the following methods:

• Michigan taxable income from the first and second months of the quarter, and the last month of the preceding quarter;
• Profit and loss statements or book income from the current quarter combined with the apportionment factor from the immediately preceding tax year;
• Michigan taxable income from the immediately preceding tax year; or
• Any alternative method previously approved by the department that results in a reasonable and accurate estimate of the amount of withholding tax due for the quarter.

The method selected for use in calculating quarterly withholding payments must be consistent throughout the tax year.

Tiered Entity Exception Discussed

The bulletin set forth an exception to the tiered-entity withholding requirements. If the member flow-through entity provides the W-4 information and ownership percentage of its individual owners to the flow-through entity in which it has an ownership interest, then that flow-through entity shall withhold Michigan income tax from the member flow-through entity's share of income available for distribution on the basis of the personal dependency exemptions and ownership percentage of its individual shareholders or partners.

The flow-through entity that has a withholding requirement must fulfill the statutory reporting requirements by reporting the share of income available for distribution and amount of tax withheld directly to the individual shareholders or partners of the member flow-through entity if it has been provided with the necessary W-4 information and ownership percentages to enable it to do so.

If the member flow-through entity in a tiered entity structure elects not to provide the W-4 and ownership percentages of its non-resident individual owners to the flow-through entity in which it has an ownership interest, then the flow-through entity required to withhold must report the required income and withholding information directly to the member flow-through entity.

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