INCOME TAX: WITHHOLDING FOR NONRESIDENT HOUSING ASSOCIATION MEMBERS
House Bill 6167 as introduced
Sponsor: Rep. Fulton Sheen
Committee: Tax Policy
Complete to 9-14-06
A SUMMARY OF HOUSE BILL 6167 AS REPORTED FROM COMMITTEE 9-13-06
House Bill 6167 would amend the Income Tax Act to address flow-through entities that have a regulatory agreement with MSHDA, HUD, or the USDA that requires agency approval for cash distributions to association members. These entities would be required to deduct and withhold taxes on cash distributions made to non-resident members in the tax year and approved under the regulatory agreement. (In essence, a withholding payment would be required only when there is an actual cash distribution made.)
Under the State Housing Development Authority Act (1966 PA 346), the Michigan State Housing Development Authority (MSHDA) provides mortgage loans to a variety of entities, including developers, to construct and rehabilitate multi-family housing projects. Typically, developers form a "limited dividend housing association," which functions as the borrowing entity. The association and MSHDA enter into a "regulatory agreement," which typically regulates such things as rental rates and tenant eligibility, and requires a portion of the rental units in the housing project to be rented to individuals with low or moderate income. In exchange for these restrictions, the association receives below- market interest rates, rent subsidies, and other tax benefits. [There are similar programs within the U.S. Department of Housing and Urban Development and the U.S. Department of Agriculture.]
Under P.A. 346, limited dividend housing associations include general or limited partnerships and limited liability companies, which in the tax laws are types of "flow-through entities" where income, gains, losses, deductions, and credits are not taxed to the entity itself, but rather "flow through" to the individual partner's or member's tax return. The act generally requires that the association's operating agreement (LLC's) or partnership agreement (LP's) or other document of basic organization provide that individual partners or members agree to restrict the amount of return on their investment to the face value of the investment, based on their respective interest, plus cumulative dividend payments limited to a rate (e.g. 6 percent) set by MSHDA and agreed to the by association in the regulatory agreement.
Under the terms of a regulatory agreement, the association may make distributions to individual partners or members only from surplus cash (i.e. the remaining available cash after all necessary and reasonable expenses have been paid).
Also, the Income Tax Act requires flow-through entities to withhold taxes on the share of taxable income available for distribution of non-resident members of the entity, after deducting the appropriate amount for personal and dependency exemptions.[1] This raises two points relative to limited dividend housing associations:
1. Many associations do not have surplus cash available to make withholding payments, meaning that withholding payments (often due even where there is no cash distribution) would have to come from operating funds or another fund source.
2. Because the withholding payment is made for the benefit of the individual partner or member (paying the partner's tax obligation or refunded to the partner when it exceeds the partner's tax obligation), it would be considered a distribution, which under the terms of the regulatory agreement could only be made from surplus cash. However, since that payment would not be made from surplus cash, it would not be in compliance with the regulatory agreement.
MCL 206.351
FISCAL IMPACT:
The bill would reduce income tax revenue by less than $1 million.
POSITIONS:
The Department of Treasury supports the bill. (9-13-06)
The Michigan State Housing Development Authority supports the bill. (9-13-06)
The Michigan Housing Council supports the bill. (9-13-06)
Legislative Analyst: Mark Wolf
Fiscal Analyst: Jim Stansell
■ This analysis was prepared by nonpartisan House staff for use by House members in their deliberations, and does not constitute an official statement of legislative intent.
[1] The non-resident withholding requirements were added to the Income Tax Act with the enactment of Public Act 22 of 2003 and effective beginning October 1, 2003, as part of an effort to increase compliance with the income tax by non-resident members of flow-through entities. Employers are also required under the act to withhold an amount for taxes. The Income Tax Act defines "flow-through entity" to mean an S corporation, partnership, limited partnership, limited liability partnership, or limited liability company. Flow-through entity does not include a publicly traded partnership that has equity securities registered with the Securities and Exchange Commission. A nonresident member of a flow-through entity is a shareholder of an S Corporation, partner in a partnership or limited partnership, or a member of a limited liability company that is an individual not domiciled in the state, or a nonresident estate or trust.