Impact of Federal Tax Reform on Michigan Exemptions
The recently passed federal tax reform may result in a tax hike for Michigan residents estimated to be more than $1.6 billion. State officials, including Gov. Rick Snyder, are scrambling to soften that blow with changes in Michigan tax laws. On Monday, Jan. 8, Snyder proposed legislation but may face an uphill battle as competing proposals from other state officials emerge. George W. Gregory practices law with George W. Gregory, PLLC, in Troy, Michigan. He was a professor with Wayne State University School of Business Administration and a revenue agent with the Internal Revenue Service from 1973 to 1980. Gregory was also one of the draftsmen of the Michigan Estate Tax Act, which repealed the old Michigan Inheritance Tax. He has written about taxes in publications including the Michigan Bar Journal, Michigan CPA, Michigan Probate and Estate Planning Journal, Michigan Tax Lawyer, and Journal of the Institute of Certified Financial Planners.
Thorpe: Did Michigan tax attorneys and CPAs see this one coming?
Gregory: No, this legislation was kept under wraps and there was not much time to review it. This was done for political reasons and resembles the actions taken on the Affordable Care Act (Obamacare). The impact on Michigan exemptions was not what people were looking at in their initial review of the legislation. Even from a state tax law impact, it was greatly overshadowed by the limitation on the deductibility on state and local taxes starting in 2018.
Thorpe: State officials have said that, under the federal reform plan, Michigan residents would pay an additional $840 million in state taxes in 2018 and more than $1.6 billion in additional taxes by 2019. Is that how you see it unfolding?
Gregory: If nothing is done, those are probably good estimates. Most Michigan tax returns have a full exemption for the taxpayer. Joint tax returns have two. More are not unusual, most of these are children.
Thorpe: Gov. Snyder resisted efforts to roll back the income tax rate in 2017, saying that Michigan’s budget problems were too severe. Are you surprised at the about-face?
Gregory: No, this was an accidental increase that he is seeking to undo. Michigan law provides a deductible exemption for the number of personal or dependency exemptions allowable for federal income tax purposes. The federal legislation increases the standard deduction and sets the personal and dependency exemption amount at zero. Gov. Snyder wants to assure Michigan taxpayers of the same exemption they had before this change. The new legislation only restores what appears to be lost, plus a little more.
Thorpe: Critics of Snyder’s proposal like Gilda Jacobs, president and CEO of the Michigan League for Public Policy, said a rollback of the state income-tax rate would primarily benefit the wealthy. Agree?
Gregory: She is correct that to the extent Michigan’s flat income tax rate is reduced, it benefits people who have more income. The higher the income the greater the reduction. Once Michigan income tax comes up, the legislators who wanted a roll back in 2017 expressed an interest in using Gov. Snyder’s proposal as a vehicle to do that. This is what Gilda Jacobs is criticizing. Gov. Snyder is aware of his constitutional mandate to balance the budget and Michigan’s declining infrastructure. Stay tuned to see what comes out of the legislature.
Thorpe: The National Tax Policy Center projects that charitable giving nationally will decline by between $12 billion and $20 billion in 2018, or between 4 percent and 6.5 percent as a result of the increase in the standard deduction and the decrease in the number of taxpayers who itemize their federal taxes. Based on your extensive experience, do you think that will happen?
Gregory: Tax savings are rarely enough to entirely motivate charitable giving. Many charitable givers are motivated in part by the tax deduction they get. Many countries have no charitable deduction and they still have charitable giving. To the extent people are motivated by tax savings and they will not be able to itemize, there will be a decrease. The National Tax Policy Center recognizes that and the estimate is not an unreasonable one.
Thorpe: Patrick Anderson, CEO of Anderson Economic Group, said in a letter to Treasurer Nick Khouri that no legislative action is needed and “Michigan’s income tax payers will not lose their state income tax exemptions ... and will not be subjected to a large income tax hike.” That opinion certainly runs counter to most. Any possibility he could be right? Are we nervously waiting for a storm that won’t arrive?
Gregory: Patrick Anderson could be right. His argument is that changing the exemption amount to zero for federal purposes, does not abolish it, it is still there. On the other hand an exemption of zero appears to be no exemption at all. This is the kind of thing that could be clarified by a rule (the Michigan equivalent of Federal Treasury Regulations). It is probably clearer, simpler and quicker to enact the legislative “fix.” If the Michigan Department of Treasury or someone else would be precluded from making the argument that zero and nothing are the same thing. This is probably easier than someone taking a case to the Michigan Supreme Court. No matter what, Michigan income tax return forms will have to be modified and we will no longer be claiming the same number of exemptions on our federal income tax return.
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