Michigan follows the section 1202 100% tax exclusion on capital gains from the sale of QSBS. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also state income taxes if all of the guidelines are followed.
Federal QSBS Exclusions and State Tax Implications
Allowing capital gains tax exclusions for Qualified Small Business Stocks (QSBS) encourages investment in US small business. QSBS laws help provide capital for these businesses while offering a savvy tax strategy for investors who want to minimize capital gains taxes.
Investors who hold qualified small business stock for at least 5 years can exclude up to $10,000,000 or more of their recognized capital gains from their taxable income if certain criteria are met.
Each state has its own treatment of QSBS gains at the state income tax level. There are three ways in which states typically address the exclusion.
- Some states fully conform to the Federal QSBS guidelines, and therefore allow a full exemption if the stock meets the Section 1202 QSBS criteria. States conform to the federal tax code on either a static or rolling basis. “Static” conformity means the state starts conforming to the Internal Revenue Code as of a specific date. “Rolling” conformity means that the state adopts IRC changes as they occur. Alternatively, certain states do not have state income taxes and therefore there is no QSBS implication at the state level.
- Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state.
- Lastly, certain states do not allow any capital gains exclusions for QSBS.
Michigan QSBS Exemptions
Michigan follows the Section 1202 100% tax exclusion on capital gains from the sale of QSBS. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also state income taxes if all of the guidelines are followed.
Michigan follows the “Static” conformity–as stated in the previous paragraphs. Michigan does, at the Corporate level, conform to the federal treatment of capital gains and losses. See Mich. Comp. Laws § 206.603(2); see also Mich. Comp. Laws § 206.623(2). Michigan does, at the Individual level, conform to the federal treatment of capital gains and losses under section 1202. See Mich. Comp. Laws § 206.30(1); see also Mich. Comp. Laws § 206.471(6); see also Mich. Admin. Code r. 206.1.
Michigan Capital Gains Tax Rates
The state of Michigan taxes capital gains at the same rate as regular income and has a flat tax rate of 4.45%.
In comparison, federal capital gains tax rates are lower than regular income and have 3 brackets for single taxpayers which are:
- 0% for $0 to $39,375
- 15% for $39,376 to $434,550
- 20% for $434,551 or more
Entrepreneurship in Michigan
TechTown Detroit is one of the state’s largest incubators. According to their website, “TechTown is Detroit’s entrepreneurship hub. We empower Detroit-based startups and local businesses by providing resources, collaborative workspace and education for entrepreneurs that will further accelerate inclusive economic development across Detroit.”
The state’s own department of commerce offers services that focus on driving progress in four main areas: trade and investment, innovation, environment, and data.
Among other industries, the following industries in particular thrive in the state:
- Medical devices
- Cyber security
- Health care
- Carbon fiber/composite materials
- Life sciences
- Information technology
Other Tax Incentives Besides QSBS that Support Entrepreneurship
There is a Michigan Business Investment Tax Credit of 2.9% as well as another small credit for compensation in the state and R&D in the state. These first two credits are capped at 65% of a taxpayer’s tax liability and all three are capped at 75% of a taxpayer’s tax liability.
Michigan Opportunity Zones
Michigan is home to approximately 288 Opportunity Zones census tracts.
Opportunity Zones (OZ) were created to help economically distressed areas by giving investors preferential tax treatment with new investments in these “specified” areas. Similar to QSBS, if the investment meets eligibility criteria and is held for at least 5 years, the investor can defer or be exempted from capital gains taxes (i.e. if held for at least 5 years, the taxpayer can exclude 10% of the gain and the percentage increases (or “steps up”) to 15% after 7 years).
Opportunity Zone investments can be in the stock of an OZ Qualified Business, an OZ partnership interest or an OZ business property.
To be a Qualified Opportunity Zone Business, the business must meet requirements such as at least 50% of the business’s total gross income being derived from within the Opportunity Zone. To learn more about Opportunity Zone qualifications, please refer to Opportunity Zones and QSBS article.
Under the Tax Cuts and Jobs Act of 2017, 26 USC 1400Z-2, Michigan made Opportunity Zones, is also home to the associated tax relief incentives that accompany these zones which are effective for tax years beginning on or after December 31, 2017. Michigan currently has 3 million residents living throughout the Opportunity Zones. Approximately 65 Opportunity Zones are located in the Rural Tract. Refer to this map for the Opportunity Zones in the state and here for all Opportunity Zones in the United States.
Some examples of Opportunity Zone funds in Michigan include:
- Chroma: A vacant nine-story 75,000 square foot building built in 1913 turned into an office and event complex
- Capital City Market: A four-story mixed use building consisting of an groceries, residential space, and a hotel
See more at Michigan Opportunity Zones.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.