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Whitmer Budget Pits Small Business Owners Against Public Pensioners

March 12, 2019

The small business community quickly called out Gov. Gretchen Whitmer’s plan to tax small business more like large corporations as a way to raise money to pay for a return to the income tax exemption on government-funded pensions.

Whitmer’s “parity” plan requires pass-through-entities like subchapter S corporations, partnerships and LLCs be taxed at the 6 percent Corporate Income Tax rate. The business owner would receive a credit for the 4.25 percent income tax rate that’s paid on his or her personal income tax form.

The proposal would exempt the first $50,000 of small business income, something the administration argues would protect the smallest businesses.

Still, it’s a 1.75 percentage-point increase that is being framed as “a 41 percent small business tax increase,” by at least one business group leader.

“They will be requiring individuals to file a brand new, additional tax return and the administrative costs will be very substantial,” warned former Lt. Gov. Brian Calley, now president of the Small Business Association of Michigan. “Think about hiring an accountant to file an additional tax return. They don’t have that cost. Not only is this a 41 percent increase, it’s an additional significant administration burden on state government and individual business taxes.”

In 2011, Calley’s former boss, then-Gov. Rick Snyder and the GOP legislature repealed the income tax exemption that shielded state, local and county government pensioners from having to pay the state’s 4.25 percent income tax on their pensions.

One of the arguments for the change was that all retiree income should be treated the same — whether public or private.

For the impacted employees, the change was quickly called a “pension tax,” a moniker that received quick public adoption. They were ticked because they retired believing that would receive a certain amount of income. The additional state taxes were not what they planned for.

The new law, which took effect Jan. 1, 2012, created a three-tiered system designed to tax some pension income for those between 66 and 60 years old and completely eliminate the tax exemption on pension income for those aged 59 and younger at the time. That 2011 package of reforms also cut the Earned Income Tax Credit from 20 percent to six percent. A tax credit that Whitmer called for doubling Tuesday to offset expected higher fuel taxes.

At the same time, the state repealed the Michigan Business Tax and replaced it with a corporate income tax rate of 6 percent. That change ended the practice where partnerships, LLCs and owners or subchapter S corporations had to pay both the state’s 4.25 percent personal income tax on income that “passed through” to the owner’s personal income tax and the state’s Michigan Business Tax on the same income.

Providing the tax relief for government pension holders would cost the state $259 million next year, rising to $355 million per year in 2021, according to the administration’s issue paper. This money would be offset, in part, by the new tax on S-Corps, which would generate $203 million in FY 2020 and $280 million in FY 2021.”

Rich Studley, president of the Michigan Chamber of Commerce, said his organization is opposed to “raising taxes on small businesses and other job providers, especially if the tax hike on employers in the private sector is to give an unfair tax break to government employees.”

According to Charlie Owens, state director of the National Federation of Independent Businesses (NFIB), the group polled its members last year and directly asked about increasing state taxes on businesses to offset the cost of pension tax relief and the reaction wasn’t warm and fuzzy.

“We have a clear member position against changing the status quo on pensions, if it means it’s going to come out of higher taxes on our businesses,” Owens told MIRS.

The question NFIB asked small business owners was:

Should any revenue shortfalls from increasing the personal tax exemptions for seniors be made up by increasing state taxes on business?

A total of 95 percent of NFIB members said no, one percent said yes and four percent were undecided. The NFIB audience was also squarely against legislation that would “treat the income received from government employee pensions and retirement plans differently from private sector plans” with 85 percent opposed, seven percent in favor and 8 percent undecided.

Public sector union officials argue the change is a matter of fairness and that corporate tax cuts were paid for in 2011 by government pension holders.

“It boils down to being a fundamental fairness issue,” said Steve Rzeppa of AFSCME. “Working people and retirees living on a fixed income shouldn’t have to bear the burden of drastic corporate tax reductions, plain and simple.”

As Senate Minority Leader back in 2012, now-Gov. Whitmer led an unsuccessful battle to force the Senate GOP into restoring the tax-exempt status of public pensions.

Sen. Jon Bumstead (R-Newaygo) said he’s not opposed to providing seniors tax relief, “as long as it helps all seniors, and not a select group hand-picked by the governor.”

According to Sen. Curtis Hertel (D-East Lansing) the change is about “keeping a promise to people when they retired that their pensions wouldn’t be taxed and I want to remind you and everyone else that they used that to pay for a $1.6 billion corporate rate decrease.”

Administration: Federal Tax Law Deductibility Minimizes Impact Of State Tax Hike
In looking at the proposed 6 percent tax for pass-through entities like partnerships, LLCs and subchapter S corporations, the Whitmer administration argues the change will allow small business owners to take better advantage of new federal deductibility rules.

Essentially, what the proposed new tax would do is, in part, put into effect SB 1170, sponsored last session by Sen. Dave Hildenbrand (R-Lowell), but vetoed by Gov. Rick Snyder. That bill would have leveled a “pass-through entity tax” equal to the 4.25 percent individual tax rate on pass through income.

The taxpayer would then be given a credit against the new “pass through entity tax” for the state income tax paid. Because it is then an “entity-based” tax rather than an individual based tax, it would allow the taxpayer to deduct from their federal tax return, more than the current $10,000 deduction cap on individual income established by the 2017 tax reform package passed by Congress and President Donald Trump.

According to the Department of Treasury, this approach differs from SB 1170 in that it would include the additional 1.75 percent increase in taxes within what could be deducted from the business owner’s federal income tax.

In other words, an owner of an LLC, partnership or subchapter S would pay 4.25 percent in personal income tax on pass through income. The state would then levy on that business owner a six percent pass through entity tax and provide them with a credit for the 4.25 percent already paid on that income through the personal income tax.

The business owner, then could deduct the entire six percent state levied entity tax against their personal federal income tax because there is no cap on entity-level tax deductibility.

They estimate that while the 1.75 percent increase in taxes would raise $280 million for the state — when you take into consideration the enhanced federal tax deductibility — holders of pass through income would only be seeing a statewide increase in tax liability of $105 million.

Calley, however, argues that the deductibility advantage is only one larger businesses that happen to be pass-through entities can take advantage of.

“When they’re figuring their numbers, it just seems like no matter what, the bigger your company is, the better you come out. For the smaller companies, this is just all pure increase for them. This just seems backward to me.” 

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