QSBS in Michigan: Conformity, the OBBBA Gap, and What Ann Arbor, Detroit, and Grand Rapids Founders Need to Know

Michigan's conformity to Section 1202 — and the OBBBA gap

Michigan uses a static IRC conformity approach — the state adopts the Internal Revenue Code as of a fixed reference date rather than automatically incorporating future federal changes. Michigan's current IRC conformity date is January 1, 2025, established by Public Act 24 (HB 4961), signed by Governor Whitmer on October 7, 2025. That act advanced Michigan's conformity from the prior date of January 1, 2018, to January 1, 2025 — a significant update, but still a date six months before OBBBA.¹

The One Big Beautiful Bill Act was signed on July 4, 2025 — after Michigan's January 1, 2025 conformity date. Michigan did not specifically decouple from §1202 in PA 24; the decoupling provisions covered IRC §§168(n) and 174A (individual income tax) and treated §§163(j), 168(k), 174, and 179 as they existed on December 31, 2024. Section 1202 was not among them. But because Michigan's conformity date (January 1, 2025) predates OBBBA's enactment (July 4, 2025), OBBBA's §1202 changes are not part of Michigan's static IRC reference — and Michigan had not passed any subsequent §1202 conformity update through September 2026.¹

This creates a three-part OBBBA gap for Michigan founders holding post-July 4, 2025 stock:

• Cap gap: Federal exclusion cap is $15M for post-OBBBA stock; Michigan cap remains $10M (or 10× adjusted basis, if larger). A Michigan founder with $15M of qualifying post-OBBBA gain excludes all $15M federally — but pays Michigan income tax at 4.25% on the $5M above the state $10M cap: $212,500 in additional Michigan tax that a rolling-conformity state founder would not owe.
• Holding period gap: Federal law allows 50% exclusion at 3 years and 75% at 4 years for post-OBBBA stock; Michigan still requires the full 5-year hold for any state-level §1202 exclusion. A Michigan founder who exits at year 3 or year 4 receives partial federal exclusion — but zero Michigan exclusion. The full gain is subject to Michigan income tax at 4.25% regardless of how many years have passed, until the 5-year mark is reached.
• Gross assets gap: OBBBA raised the gross assets threshold at issuance from $50M to $75M for post-OBBBA stock. Michigan still applies the $50M threshold for all stock. A company with $60M in gross assets at the time of share issuance qualifies federally under OBBBA's $75M threshold — but may not satisfy Michigan's $50M limit, meaning the Michigan §1202 exclusion would not apply even if the federal exclusion is fully available.

This situation is similar to Massachusetts, which also uses a static IRC conformity date (January 1, 2024) that predates OBBBA. Rolling-conformity states — including Connecticut, New York, Illinois, Colorado, New Jersey, and Utah — automatically adopted OBBBA's §1202 enhancements the moment the bill was signed, with no state legislative action required. Michigan's static conformity structure means a new state law is needed to capture OBBBA's §1202 changes. See the Massachusetts QSBS guide for the comparable MA analysis and the state conformity overview for the full 50-state map.

Michigan's 4.25% flat rate and what Section 1202 saves

Michigan imposes a flat individual income tax rate of 4.25% for the 2026 tax year. The statutory conditions for a rate reduction were not met for 2026 — general fund revenue declined by 1.56% while inflation ran at 2.70%, leaving the rate unchanged from prior years.² Michigan taxes capital gains as ordinary income at the same 4.25% flat rate. There is no preferential Michigan rate for long-term capital gains — unlike the federal system, which offers 0/15/20% LTCG rates, Michigan applies the same 4.25% to all gain regardless of holding period.

The Section 1202 exclusion eliminates Michigan income tax on excluded gain. State-level savings by scenario:

• Pre-OBBBA stock, $10M qualifying exit (5-yr hold): Michigan and federal caps aligned; Michigan state tax savings = $10M × 4.25% = $425,000
• Post-OBBBA stock, $10M qualifying exit (5-yr hold): Michigan still uses $10M cap → savings same: $425,000
• Post-OBBBA stock, $15M qualifying exit (5-yr hold): Federal excludes $15M; Michigan excludes only $10M → Michigan state tax on the $5M cap gap = $5M × 4.25% = $212,500; Michigan savings on the $10M excluded = $425,000

These amounts stack on top of the federal benefit. A full §1202 exclusion on a $10M qualifying exit eliminates approximately $2.38M in combined federal LTCG tax and NIIT (at the 5-year mark) plus $425,000 in Michigan state tax — a combined benefit exceeding $2.8 million in total tax eliminated for a Michigan-domiciled founder.

Michigan city income taxes do not apply to capital gains

Twenty-four Michigan cities impose a city income tax — including Detroit (2.4% for residents), Grand Rapids (1.5%), Lansing (1%), Ann Arbor (1%), and East Lansing (1%). These city income taxes apply to wages, salaries, and net business income for residents and non-residents working within city limits. Michigan city income taxes do not apply to capital gains or passive investment income.³

A Detroit-resident founder whose QSBS shares generate a $15M gain owes zero Detroit city income tax on that gain — only the 4.25% Michigan state rate applies (and only on the non-excluded portion). This distinguishes Michigan from New York, where NYC residents pay city income tax on ordinary income; capital gains from stock sales by out-of-city Connecticut residents are not subject to NYC city tax, but NYC-resident founders pay city tax on non-excluded QSBS gain.

Ann Arbor health tech and University of Michigan spinoffs: the §1202(e)(3)(A) health exclusion

The University of Michigan's commercialization ecosystem — spanning Michigan Medicine, the College of Engineering, the Ross School of Business, and UM's Innovation Partnerships office — generates significant startup activity in Ann Arbor and the surrounding corridor. U-M spinoffs cover health tech, deep tech, advanced manufacturing, and mobility. Michigan founders with UM-affiliated companies must carefully analyze §1202(e)(3)(A) before relying on the §1202 exclusion.

IRC §1202(e)(3)(A) excludes businesses "in the field of health" where the company's principal asset is "the reputation or skill of 1 or more of its employees." The exclusion targets clinical care delivery, not research, technology development, or device manufacturing.

Life sciences R&D, medical devices, and health IT: generally qualifying

• Medical device designers and manufacturers: Michigan has a significant medical device cluster — orthopedic devices, surgical robotics components, diagnostic imaging hardware, and biosensors. Companies that design, develop, and manufacture FDA-regulated medical devices are primarily product companies whose principal asset is proprietary engineering, IP, and manufacturing capability — not the clinical skill of employee practitioners rendering care to patients. Medical device companies are generally in the manufacturing and technology fields, not the health services field.
• Pharmaceutical and biosciences R&D: The Kalamazoo corridor — anchored by Pfizer's legacy operations and a network of early-stage drug discovery companies — includes companies developing small-molecule drugs, novel biologics, and diagnostics. These companies' principal assets are drug candidates, preclinical platforms, and IP portfolios, not physician skill. Preclinical and clinical-stage pharma companies are generally in the pharmaceutical research field.
• Health IT and clinical software: Software companies selling electronic health record tools, hospital operations management platforms, revenue cycle management software, or clinical decision-support tools to healthcare institutions — where the company earns SaaS or licensing revenue and the healthcare institution delivers care — are generally in the technology field. The company's principal asset is its software platform, not the clinical skill of its engineers or employees.
• Consumer-facing digital health tools: Apps and platforms for chronic disease management, behavioral health support, or remote monitoring require more careful analysis. If the company's product is software (the company employs engineers; the customer uses the software to manage health), the company is in the technology field. If the company's primary service includes licensed clinicians delivering virtual care encounters to users, the §1202(e)(3)(A) health exclusion risk increases.

Clinical care delivery: excluded

• Physician group practices, hospital management companies, and practice management firms — where the company's principal assets are physicians or other licensed clinicians delivering care — are excluded under §1202(e)(3)(A)
• Telehealth platforms whose primary revenue is from clinical encounters delivered by company-employed licensed practitioners
• Home health agencies, behavioral health practices, and therapy services companies where licensed practitioners deliver services directly to patients
• Michigan Medicine-affiliated clinical operations entities, regardless of technology investments

For the full §1202(e)(3)(A) statutory framework — including IRS guidance on borderline software-plus-care models — see the excluded industries guide.

Detroit EV and auto tech founders: §1202(e)(3) analysis for Michigan's automotive startup ecosystem

Southeast Michigan's automotive heritage has produced a growing cluster of technology startups in electric vehicles, autonomous vehicle software, fleet management, supply-chain analytics, and mobility platforms. These companies often intersect with the traditional automotive supply chain in ways that create nuanced §1202(e)(3) questions.

Automotive software and technology companies: generally qualifying

• EV powertrain and battery management software: Companies that build and license battery management systems, charging network management platforms, or EV fleet analytics software — where revenue is from technology licenses or SaaS subscriptions — are in the software field. The §1202(e)(3) exclusions do not cover software and technology development companies.
• Autonomous vehicle and ADAS software: Companies developing LIDAR processing software, perception systems, or ADAS calibration tools sold to OEMs or Tier 1 suppliers — where the company earns technology license revenue and the OEM or supplier deploys the product — are in the software and engineering field. The principal asset is proprietary algorithm development and IP.
• Supply chain analytics and manufacturing tech: Software platforms automating automotive supply chain visibility, quality management, or manufacturing floor operations — sold to OEMs and suppliers on a SaaS basis — are in the technology field without §1202(e)(3) exclusion risk.

Consulting and automotive financial services: exclusion risk

• Engineering consulting firms: Companies whose primary revenue is engineering consulting services — deploying engineers as consultants at client sites rather than building and licensing a product — face §1202(e)(3)(A) consulting exclusion risk. The key question is whether the company's principal asset is its proprietary technology or IP (product-led) or the skill of its individual engineers (services-led). A company billing primarily by the hour at client sites may be in the consulting field; a company licensing software or hardware products is generally not.
• Dealer financial services and automotive fintech: Companies in automotive floor-plan financing, dealer lending, or vehicle insurance — where the company holds financial risk or earns interest income from financing activities — face §1202(e)(3)(B) banking and financing exclusion risk. Fintech software that processes dealer financing applications as a SaaS product is different from a company that funds the loans itself.
• Vehicle leasing and rental platforms: Platforms that directly lease vehicles to end customers may face §1202(e)(3)(B) "leasing" exclusion analysis. A platform licensing fleet management software to operators is generally qualifying; a platform that itself leases the vehicles may not be.

For Michigan founders in the automotive-adjacent startup ecosystem, the §1202(e)(3) question turns on whether the company's principal economic activity is a qualifying active business (technology product, manufacturing, software) or a service activity within an excluded field (consulting, financing, leasing). A written §1202(e)(3) legal opinion from qualified tax counsel is advisable before any gifting or holding-period strategy is built around the exclusion. See the excluded industries guide.

The OBBBA gap in practice: Michigan tax at 3-year, 4-year, and 5-year exits

For Michigan founders holding post-July 4, 2025 stock, the OBBBA gap creates a divergence between federal and Michigan tax treatment at shorter holding periods:

For Michigan founders holding pre-OBBBA stock (issued before July 4, 2025), the OBBBA gap does not apply. Both Michigan and federal use the same pre-OBBBA rules: $10M flat cap (or 10× basis), 5-year hard cliff, $50M gross assets, 100% exclusion for post-2010 stock. A $10M pre-OBBBA qualifying exit produces $0 Michigan state tax. See the OBBBA guide for the full pre/post comparison.

Michigan QSBS worked examples

Michigan versus peer states: QSBS comparison

Michigan's 4.25% flat rate produces the lowest dollar savings per dollar of exclusion among the income-tax states shown — only Texas and other no-income-tax states produce a larger effective benefit by eliminating state tax entirely. But Michigan's §1202 conformity is a meaningful advantage over California, where founders with identical positions pay 13.3% on the full gain regardless of federal exclusion. Michigan's OBBBA gap puts it in similar territory to Massachusetts — both have static conformity dates predating OBBBA, both recognized pre-OBBBA §1202, and both await state legislative action to capture the OBBBA enhancements. Michigan's static date (January 1, 2025) is one year more recent than Massachusetts's (January 1, 2024).

Planning priorities for Michigan founders

1. Document issuance date — the OBBBA gap only affects post-July 4, 2025 stock

For stock issued before July 4, 2025, Michigan and federal §1202 are fully aligned and there is no OBBBA gap to plan around. For stock issued after July 4, 2025, the Michigan conformity date structure means OBBBA's three enhancements ($15M cap, tiered schedule, $75M gross assets) do not automatically apply at the state level. Founders with mixed lots — some pre-OBBBA and some post-OBBBA — need to track issuance dates for each lot separately for state planning purposes, in addition to federal lot-by-lot analysis. Use the documentation guide to confirm issuance records for each grant or purchase date.

2. Target the 5-year hold — OBBBA's tiered schedule does not shorten Michigan's cliff

OBBBA's federal tiered schedule can give Michigan founders a false sense of flexibility. At the Michigan level, the 5-year hard cliff still applies regardless of OBBBA. A 3-year or 4-year exit produces $0 Michigan §1202 exclusion, even if the federal benefit is partially realized. On a $15M post-OBBBA exit at 4 years, the Michigan founder pays $637,500 in Michigan income tax on top of the federal 28% rate trap on the non-excluded portion. The Michigan state component alone — which goes to zero at year 5 — may be larger than founders realize when planning around OBBBA's tiered schedule. If a transaction timeline has any flexibility, the 5-year mark produces the best combined federal-plus-Michigan outcome.

3. Resolve the §1202(e)(3) excluded-industry question before any planning

Michigan's §1202 conformity only saves state tax if the company's stock actually qualifies under all eight federal §1202 tests. The §1202(e)(3)(A) health exclusion is the primary risk for Ann Arbor university spinoffs and Grand Rapids life sciences companies — the analysis turns on whether the company's principal asset is proprietary technology, devices, or research IP (generally qualifying) versus the clinical skill of employee practitioners (excluded). The §1202(e)(3)(A) consulting exclusion applies to Detroit and Southeast Michigan engineering services firms whose principal business is billable consulting labor rather than a licensed product. The §1202(e)(3)(B) banking and financing exclusion applies to automotive fintech and dealer financial services companies that hold financial risk rather than selling software to those who do. Get a written §1202(e)(3) opinion from qualified tax counsel before any gifting, trust planning, or holding-period optimization. See the excluded industries guide.

4. Multiply the Michigan exclusion cap through gifting before a transaction

Each donee who receives QSBS through a completed gift before a binding sale receives their own §1202 exclusion cap — $10M at the Michigan level (for pre-OBBBA stock or until Michigan captures OBBBA). A Michigan founder with $30M of qualifying QSBS gain who gifts shares to a Michigan-resident spouse and two adult children before signing a letter of intent can potentially stack four separate $10M Michigan exclusion caps — eliminating up to $1.7M in Michigan state tax compared to a single-holder exit. The gift must be completed before any binding obligation to sell; after a letter of intent or merger agreement is signed, anticipatory assignment of income rules apply and the tax benefit may be lost. See the gifting and stacking guide for the timing rules and the trusts guide for non-grantor trust stacking strategies.

5. California-to-Michigan domicile: §1202 conformity is the main tax advantage — genuine relocation required

For California-resident founders approaching a QSBS liquidity event, Michigan's §1202 conformity represents a significant planning advantage: California taxes the full QSBS gain at up to 13.3%, while Michigan excludes up to $10M at the state level. On a $10M qualifying exit, the state tax difference is approximately $1,330,000 avoided. However, establishing Michigan domicile before a sale requires genuine relocation — California FTB applies a detailed domicile analysis that examines where a taxpayer spends time, maintains business relationships, where family lives, and where the "closest contacts" are. Founders who establish California residency and relocate shortly before a liquidity event face elevated FTB audit risk. Equity compensation that vested while the founder was a California resident may also be partially sourced to California regardless of domicile at the time of sale. See the California QSBS guide for the full FTB domicile and equity compensation sourcing analysis.

Talk to a QSBS advisor about your Michigan situation

Michigan's §1202 conformity eliminates up to $425,000 in state tax on a $10M qualifying exit — but the OBBBA conformity gap for post-July 2025 stock, the 5-year hard cliff that Michigan still imposes regardless of OBBBA's federal tiered schedule, the §1202(e)(3) excluded-industry analysis for Ann Arbor health tech, Detroit auto software, and Grand Rapids medtech companies, and the pre-transaction planning window for gifting and trust structures all require professional review. A fee-only financial advisor who specializes in QSBS and founder liquidity can confirm qualification, model the full federal-plus-Michigan tax picture, clarify the current status of Michigan's OBBBA gap, and integrate QSBS planning with estate and charitable goals before the opportunity closes.

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