Governor Snyder presented his Fiscal Years 2012 and 2013 Executive Budget Recommendation to a joint session of the House and Senate appropriations, finance, and tax policy committees on Thursday, February 17. The Governor followed through on his campaign promise by including in the proposed budget a repeal of the Michigan Business Tax (MBT) and replacing it with a flat 6 percent corporate income tax. However, many observers were surprised by the significant changes proposed to the individual income tax. Snyder’s administration stated that the overriding objective of these changes is to position the Michigan tax system as “more simple, fair, and efficient.” The administration is targeting May 31, 2011, for the legislature to adopt the budget.
Repeal Michigan Business Tax, Enact Corporate Income Tax
The proposal calls for a repeal of the MBT effective December 31, 2011 and enactment of the corporate income tax effective January 1, 2012. The corporate income tax would be levied on “C” corporations at a rate of 6 percent of federal taxable income, subject to limited state tax base adjustments.
“S” corporations, partnerships, limited liability companies, and sole-proprietorships would be exempt from the corporate income tax. The administration estimates that 95,000 businesses would no longer be subject to a business-level tax. The administration’s intent is to eliminate the double taxation on business activity of pass- through entities and proprietorships that exists today, which subjects (1) the activity of these types of businesses to the MBT and (2) the owners of these businesses to individual income tax on the income of the businesses.
Under the umbrella of the proposed corporate income tax, in lieu of the 6 percent tax on taxable income, insurance companies would remain subject to a gross premiums tax, and financial institutions would remain subject to a franchise tax on taxable capital.
The proposed corporate income tax excludes retention of tax credits, except for the small business credit. Many have raised concerns regarding the absence of economic incentive tax credits, such as the MEGA payroll credits, the Brownfield credit, and the historic preservation credit.
The Governor plans to honor existing economic incentive tax credit commitments, although the mechanics of how that will be achieved are still unknown. However, there are plans to exclude the issuance of future economic incentives from the tax system. Instead they will be handled through the appropriations process, the intent of which is to keep the tax code as simple as possible and increase the transparency of granting economic-based incentives.
The revenue impact of these business tax changes on the state of Michigan is projected at approximately $1.8 billion on a full fiscal year basis. The Governor plans to compensate for the business tax revenue decrease through changes to the individual income tax, again under the premise of making the individual income tax more simple, fair, and efficient.
Individual Income Tax Changes
The underlying theme of the proposed individual income tax changes is “all taxpayers should pay the same rate regardless of source of income.” Based on this principle, the Governor recommends eliminating all individual income tax deductions and credits, except for the personal exemption, the exemption for individuals with disabilities, special provisions for military personnel and veterans, the homestead property tax credit, and “other minor” deductions.
The Governor has recommended that the retained personal exemption be phased out for single taxpayers with income in excess of $75,000 and for married joint filers with income in excess of $150,000. Currently, there is no phase out of personal exemptions.
Similarly, while the homestead property tax credit is intended to be retained, changes are proposed to the method of computing the credit. The homestead property tax credit base is computed as the amount by which the real property taxes on one’s principal residence exceed 3.5 percent of household income. Taxpayers that are 65 years of age or older are eligible for a credit equal to 100 percent of the credit base, while taxpayers under 65 years of age are eligible for a credit equal to 60 percent of the credit base. The maximum credit is $1,200 for all taxpayers. The Governor’s proposal is to modify the credit computation so that the eligible credit amount is 80 percent of the credit base for all taxpayers, regardless of age. Further, the credit is currently phased out for those taxpayers with household incomes between $73,650 and $82,650. The Governor proposes to reduce the phase-out range to $61,000 to $70,000.
The deduction elimination that is receiving the most public attention is the proposed elimination of the pension and retirement distribution deduction. Currently, distributions from federal, state, and local public pensions are fully exempt and distributions from private retirement plans are exempt up to $45,120 for single taxpayers and up to $90,240 for married joint filers.
The Michigan individual income tax rate is currently 4.35 percent and is scheduled to be reduced to 4.25 percent effective October 1, 2011. The rate is scheduled to be reduced an additional 0.1 percent each October 1 during years 2012 through 2014 and, ultimately, reduced to 3.9 percent effective October 1, 2015. The Governor recommends retaining the currently scheduled rate reduction of 4.25 percent but eliminating the subsequently scheduled rate reductions.
The Michigan Department of Treasury has estimated the combined business tax and individual income tax recommended changes will result in a $254.1 million state revenue decrease for fiscal year 2012 and a $32.1 million state revenue increase for fiscal year 2013.