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Michigan’s New Tax and Withholding Requirements for Retirement Income

November 11, 2011

Michigan Tax Law has changed for 2012 and thereafter to make more "retirement income" subject to the Michigan Income Tax than in previous years.  Retirement income includes defined benefit pensions, IRA distributions, and most payments from defined contribution plans.   Retirement income does not include military pensions, social security benefits, or railroad retirement benefits.  The new tax rules are "phased in" and will affect primarily retirees who were born after 1952.

At present, Michigan Income Tax law exempts retirement income in amounts of approximately $45,000 for single taxpayers or married taxpayers filing separately, and $90,000 for married taxpayers filing joint returns.   Beginning in 2012, these generous exemptions will continue to apply to taxpayers who were born prior to 1946, but the exempt amount will be reduced substantially for taxpayers born after 1945.

The exempt amounts for 2012 are as follows:

(a) Retirees born prior to 1946:   The total amount received from governmental retirement plans plus $45,842 for single taxpayers or married taxpayers filing separately, and $91,684 for married taxpayers filing jointly.

(b) Retirees born during 1946 through 1952:   $20,000 for single retirees and married retirees filing separate returns, and $40,000 for married retirees filing joint returns. 

(c) Retirees born after 1952:   No exemption.

Prior to 2012, plan administrators were not required to withhold for Michigan Income Tax purposes.   Beginning in 2012, the federal rules remain the same, but Michigan is requiring withholding on "taxable pension benefits."   In addition to the exemptions listed above, the withholding rules add an additional "personal exemption allowance" of $3,700 per year ($308.33 per month) for each dependent that the retiree claims for tax purposes.  

For retirees born prior to 1946, administrators are required to withhold only on retirement income from private pension sources in excess of the exempt amount shown above.

For retirees born in 1946 through 1952, the withholding requirement will apply only to amounts in excess of $1,975 per month for single retirees with no additional dependents and $3,950 per month for married retirees filing joint returns and with no additional dependents.   Plan administrators will have to withhold 4.35% on the amount of each monthly pension in excess of these amounts. 

EXAMPLE:   Let's assume that a retiree born in 1948 has a pension of $4,000 per month.   Let's also assume that the retiree is married and files a joint tax return.   The plan will be required to withhold 4.35% on the amount of the pension in excess of $3,950 per month so the total withholding for Michigan Income Taxes will be $2.18 per month.

$4,000 (monthly pension) - $3,950 (exempt amount) =
$50 x 4.35% = $2.18

For retirees born after 1952, the withholding will be equal to 4.35% of the amount of retirement income in excess of their "personal exemption allowance" of $308.33 per month per personal exemption.   Thus, for a married retiree who is age 59 or less in 2012, the withholding requirement will apply to the amount of the pension that is in excess of $618.66 per month.

EXAMPLE:   Let's assume that a married retiree born in 1953 has a monthly pension of $4,000 and files a joint tax return.   The plan will be withholding the sum of $147.09 each month for Michigan Income Tax purposes.

$4,000 (monthly pension) - $618.66 (exempt amount) =
$3,381.40 x 4.35% = $147.09

There are some additional complications in the Michigan Tax Law concerning retirement benefits.   Premature payments from retirement plans, that is, payments before the recipient was eligible for payment, are not considered retirement income and therefore are not eligible for the exemptions noted above.   These amounts are fully taxable when received.   Moreover, benefits from 401(k), 457, or 403(b) plans are not eligible for the exemptions if the only contributions to these plans were made by the employee.   Most of these plans, especially 401(k) plans, have employer matching or discretionary contributions that will qualify the retirement distributions for the exemptions.

Plan administrators should be sending out new withholding forms (MI W-4P) for retirees to complete and return showing the number of dependents they wish to claim for the personal exemption allowance.   Retirees should be encouraged to complete and return these forms so that the administrator can give them the benefit of all their personal exemptions in applying the Michigan withholding rules.   Retirees may use this form to opt out of the withholding requirement if they believe that the payments are not taxable and they may increase the amount to be withheld beyond the amount required for the number of exemptions claimed.

If you have any questions about the new requirements, please a contact a member of our Employee Benefits Practice Group.  The members of the group are:

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