Michigan Gov. Gretchen Whitmer recently vetoed legislation that would have created a pass-through entity tax to minimize the impact of the $10,000 individual limitation of the federal state and local tax deduction. As in many other states, the law would have allowed pass-through entities to elect to pay taxes at the entity level. Partners, shareholders and members of those entities could then claim credit for their share of taxes paid. The workaround to the federal limitation essentially allows owners to re-characterize the non-deductible individual state income tax expense to a deductible state income tax expense for federal income tax purposes.
The workaround passed overwhelming in both chambers of the legislature (29-6 in the Senate, and 88-18 in the House). In her veto message, noting the $5 million cost of the implementing the program, Gov. Whitmer stated that the tax should be part of a larger budget discussion and that the “tax break that would primarily benefit a small number of Michiganders." Interestingly, former Gov. Rick Snyder also vetoed a pass-through entity tax measure in 2018.
The legislature must decide whether to try to override the governor’s veto, which would presumably pass considering the overwhelming original vote, or re-refer the bill to committee.
RSM state and local tax policy experts provide their take on the governor’s veto.
As a rule of thumb, robustly bi-partisan tax legislation in a fairly evenly split state is not usually the subject of a governor’s veto. Layer on that this type of entity-level tax election is a fairly benign approach to re-allocating federal tax dollars to mostly small and middle-market business owners at minimal cost to the state, and I was shocked that Gov. Whitmer pushed back on Michigan’s legislative branch. The simple truth is that, in the absence of the vetoed election, Michigan taxpayers will bear a federal tax burden that taxpayers in other states will not. Why leave that type of disparity in place when the very people impacted are more mobile than they ever have been? That is the question Michigan legislators will be considering when they look at whether to push for a veto override. And, in spite of its long history of failed veto override attempts, this bill is one where the votes are there by all indications and the issue is not mired in partisanship. Of course, it would all be easier if the SALT deduction limitation would just go away, but that is not the world we live in. Michigan legislators recognized it. Gov. Whitmer did not. And, the United States has many pleasant peninsulas.
I’ve always been a fan of Gov. Whitmer. I’m lukewarm on the federal SALT deduction limitation. While currently scheduled to end after 2025, the federal savings is enormous, with estimates exceeding $1 trillion over a decade. And yes, repealing the cap entirely would benefit mostly high-income earners. But I do think it is plausible that the limitation will survive, in some form, after the initial period. That said, a state workaround should still be a no-brainer, because, while the workarounds have no meaningful impact on state revenues, they could have substantial impact on the taxpayers that will benefit.
Frankly, the workarounds are a gift to wealthier state taxpayers and, perhaps, an incentive to keep those tax dollars in-state, rather than relocating to lower-tax jurisdictions. While I believe so-called ‘SALT cap migration’ is over-exaggerated, it is certainly not non-existent. High-earners in high-tax states will consider residency planning to reduce overall federal and state tax burdens – this is not a 21st century dynamic. What is different today is the ease of remote work: the cloud, video conferencing, VPNs, powerful mobile computers and phones, and a willing workforce have demonstrated that remote work…well, it works. Embraced by both business communities and employees. State legislatures have also begun to recognize the future of hybrid or entirely remote work through various income credits and incentives to new remote workers. The point, and I have one, is that high-earners are no longer shackled to desks in New York City, or in this case the greater Detroit metro area. Maybe throwing them a bone at essentially no cost to the state isn’t the worst idea, and may prevent some of those high-earners from dreaming about the sandy shores of the Sunshine State, the soulful sounds of the Volunteer State, or the bar-b-que and vastness of the Lone Star State – all states without an individual income tax. That’s not to say the governor missed the mark completely, Michigan has more work to do and if there is ever a time to do it, it’s now when state revenue collections are robustly above forecasts.
I must admit that I do not understand the veto. At least 17 states have enacted pass-through entity tax workarounds. They cost the state no tax revenue. And, did the governor really veto this over the $5 million administrative cost? In a $67 billion budget? There is a cost of course; that cost is borne by taxpayers across the country. The governor noted that the tax break is narrowly tailored. Like all pass-through entity taxes that is true. Only owners of pass-through entities will enjoy the ability to skirt the federal SALT deduction limits. Those owners tend to be wealthier than most. C corporation shareholders and plain old employees will not benefit. Perhaps Gov. Whitmer based the veto on good tax policy. Still, you would think the politics are on the side of override. The law benefits some Michiganders and hurts none. The business community seems solidly behind the new tax. My money will be on an override for those reasons.