(As seen on WZZM TV 13) When Gov. Gretchen Whitmer presented her 2020 fiscal year state budget proposal on March 5, small business groups immediately objected to her plan to offset a pension tax repeal by increasing taxes on small businesses, or “pass-through” entities.
Whitmer campaigned on a platform to fix Michigan’s infrastructure, as well as to increase education funding, make health care more affordable and repeal the retirement tax, which was passed under former Gov. Rick Snyder’s administration in 2011 and subjects pension income for those born after 1952 to a tax that those who hold 401(k) or 403(b) retirement accounts do not have to pay.
The plan to repeal the pension tax enjoyed bipartisan support during the 2018 governor’s race, with Republican candidate Bill Schuette also advocating for it.
Neither Whitmer nor Schuette fully explained at the time how they would offset the loss of approximately $300 million in annual income generated by the pension tax.
Whitmer’s budget plan accounts for most of the gap — about $280 million — by broadening the 6 percent corporate income tax (CIT) to include sole proprietorships, partnerships, S corporations and limited liability companies (LLCs).
These types of businesses are known as pass-through entities, or flow-through entities, because they are not currently subject to corporate income tax. Instead, the owners are charged a 4.25 percent individual income tax by the state that adjusts for profit and losses in a given year.
Whitmer’s plan is to transition small entities from the 4.25 percent individual income tax to the 6 percent corporate income tax rate.
State Budget Director Chris Kolb said in the March 5 presentation that pass-through entities paying the new 6 percent rate would be able to deduct $50,000 off their income taxes, so if they made $60,000 in 2020, only $10,000 of it would be taxable.
Kolb added the increase also would be offset by allowing pass-through entities to deduct their state taxes from their federal returns.
He said other options that were considered to raise the $2.5 billion funding increase in Whitmer’s budget plan — which includes a gas tax for road improvements and funding for education, health care and clean water initiatives — were raising the individual income tax from 4.25 percent to 5.3 percent; increasing the corporate income tax rate from 6 percent to 19.5 percent; bumping the sales and use tax from 6 percent to 7.4 percent; levying a new statewide property tax at 7 mills; and increasing vehicle registration fees by 180 percent.
On the same day Whitmer announced her plan, the Small Business Association of Michigan (SBAM) weighed in, calling it “a step backward” for Michigan’s small businesses.
The group, led by CEO Rob Fowler, estimated the proposed pass-through tax increase would amount to a 41 percent real increase in taxes, which would impact more than 100,000 small businesses.
He said he believes the legislation is reminiscent of the Michigan Business Tax, signed into law by former Gov. Jennifer Granholm in 2007 and repealed by Snyder in 2011. The MBT taxed the business income of all taxpayers on top of their personal income tax liability.
“Michigan has made substantial economic gains in employment since double taxation on small businesses was eliminated in 2011,” Fowler said. “Gov. Whitmer’s proposal would be a major step backward and a job-killer for small businesses, which make up most of the employment and employment growth in our state.”
The Grand Rapids Chamber of Commerce also came out against the small business tax portion of Whitmer’s plan.
“This tax goes against the chamber’s priority of creating a vibrant business climate, and we will be advocating against a tax increase that would place additional burdens on small business,” the organization said in a statement on its blog.
Tom Mathison is past chair of SBAM, as well as principal and co-founder of Grand Rapids-based Mathison | Mathison Architects, which has about $2 million in annual sales and would not benefit much from the $50,000 exemption, he said.
“The interesting thing to me is that a special attention tax is being applied to small businesses, which really account for 60 to 70 percent of all jobs in Michigan. Certainly, the vast majority of job creation is done in small businesses,” he said.
“I can only speculate that a return to the way it was back before 2011 with the MBT will simply stifle that growth. … Back around 2010, we were almost last in the country in terms of business environment, and most of it was attributed to the MBT. So, to go back to that, I think we’ve already seen that movie.
“We know what’s going to happen. It’s going to have a negative effect on job creation. There will be less money for small businesses to have to expand or hire new people.”
He said he has not heard any alternative suggestions from SBAM yet as to how they would propose generating revenue to meet some of the bipartisan goals of the tax plan, including repealing the pension tax.
Phil Mitchell, president at Kroon & Mitchell Integrated Tax and Investments in Grand Rapids, said he is not sure the claims the Whitmer administration made about the provisions of the bill that would offset the tax hike are true.
“Even if you can write something off — let’s say when you write off a charitable deduction, if you give someone $100 — you don’t save $100; you’re saving a portion of that,” he said.
“So, we would want to see in more detail exactly how that would work, to see if that’s really a 100 percent accurate comment.”
Generally speaking, Mitchell said when states raise taxes, offsets don’t provide “dollar-for-dollar” benefits.
“I’m not sure how, if you pay more taxes, your taxes will go down,” he said.
Mitchell added he believes the tax changes would create a “negative preference” against sole proprietorships.
“We’re getting into more of a gig economy, where people are contractors, or real estate agents, where there are independent contractors, and they’re already paying a self-employment tax, as well,” he said. “So, there’s a lot of other tax already occurring. That part is sort of missed out on. We’re not talking about the company that made a couple of billion in revenue or profit; you’re talking about someone just making $60,000 of income, and this is a pretty big (addition), even if only $10,000 of that is now taxable.”
Mathison and Mitchell both said if the budget were to pass as is, business owners would have to spend additional time and money preparing an extra tax return to account for the changes.
The budget is now in front of the Legislature, and a final version is expected by May or June.
Whitmer and Kolb’s video presentation of the budget proposal, with feedback from the Joint House and Senate Appropriations Committee, is available at bit.ly/2020budgetproposal.