Michigan Updates Guidance on Tax Treatment of Retirement Income

By Peter G. Pupke

The Michigan Department of Treasury issued a release that discusses the tax treatment of retirement and pension income following changes to Mich. Comp. Laws Ann. § 206.30 enacted by Public Act 4 of 2023 (PA 4) (see State Tax Update, 03/08/2023). It updates and supplements Michigan Revenue Administrative Bulletin No. 2017-21, 10/10/2017 (tax treatment of retirement income from IRC § 403(b) plans) and Michigan Revenue Administrative Bulletin No. 2018-18, 10/22/2018 (deduction of retirement and pension benefits from a public retirement system). (Michigan Revenue Administrative Bulletin No. 2023-22, 11/22/2023.)

Prior Michigan tax treatment of retirement distributions.

Before Public Act 38 of 2011 (PA 38), taxpayers could subtract most qualified retirement distributions on the Michigan return with some dollar limitations on distributions from private employers, certain public employers from other states, and on qualified distributions from individual plans such as IRAs and senior citizen annuities. PA 38, effective for tax years 2012 through 2022, limited the subtraction for certain recipients based on the taxpayer’s date of birth for a single or married filing separate filer or the date of birth of the older spouse for joint filers, separating taxpayers into three age-based tiers. A taxpayer’s age for purposes of the retirement income deduction is determined by their age on December 31 of the applicable tax year. Taxpayers born before 1946 continued to be treated the same as under prior law. For taxpayers born during or after 1946, new lower limits were placed on the retirement income deduction, depending on year of birth and age at the end of the tax year.

The limitations on retirement income deductions beginning in tax year 2012 separated taxpayers into three-tiers:

• Tier 1: Taxpayers born before 1946 were not subject to any limitations on retirement income deductions other than those in place under prior law, meaning the subtraction for retirees in this tier remained unlimited for all retirement benefits received from public sources; the subtraction for retirement income earned in another state continued to be subject to the inflation-indexed private retirement maximum or the amount allowed by the other state to its residents on Michigan earned retirement income; and individuals with both public and private sourced retirement income were still required to reduce the maximum allowable subtraction for the private retirement income by any public retirement subtraction and any amounts claimed on Michigan Schedule 1 for military retirement benefits due to service in the U.S. Armed Forces or Michigan National Guard or due to taxable railroad retirement benefits.
• Tier 2: For taxpayers born in 1946 through 1952, the maximum retirement income deduction was $20,000 for a single filer or $40,000 for joint filers, reduced by any amounts claimed on Schedule 1 for military retirement benefits due to service in the U.S. Armed Forces or Michigan National Guard or due to taxable railroad retirement benefits. At age 67, the $20,000/$40,000 deduction was no longer restricted to retirement income, but could be applied to all income, and was therefore referred to as the standard deduction.

  For taxpayers who received retirement or pension income from a governmental agency that was not covered by the federal Social Security Act, the “uncovered” taxpayer could deduct $35,000 on a single return and $55,000 on a joint return (or $70,000 on a joint return if both spouses were “uncovered”). After that taxpayer reached age 67, this deduction was available against all income.

• Tier 3: For taxpayers born after 1952 there was no retirement income deduction. One narrow exception allowed a limited deduction for taxpayers aged 62 who received a retirement income from a governmental agency that was not covered by the federal Social Security Act. Those “uncovered” taxpayers who were at least 62 years old could deduct $15,000 or, if both spouses were “uncovered,” $30,000.

Upon reaching age 67, all taxpayers were eligible for the $20,000/$40,000 standard deduction against all income reduced by any taxable Social Security income and personal exemption and by any amounts claimed on Schedule 1 for military retirement benefits due to service in the U.S. Armed Forces or Michigan National Guard or due to taxable railroad retirement benefits. Alternatively, a taxpayer could elect to forgo the standard deduction and instead deduct taxable social security benefits and the personal exemption.

Additionally, “uncovered” individuals that were retired as of January 1, 2013, could claim the $20,000/$40,000 pension/retirement subtraction plus an additional $15,000 for the “uncovered person,” and upon reaching the age of 67, could claim the $20,000/$40,000 standard deduction plus an additional $15,000 for the “uncovered person” unreduced by the personal exemption claimed or any subtraction taken for social security income.

Beginning in 2020, special rules applied for determining the tier limitation applicable to surviving spouses. A surviving spouse could compute the subtraction based on the date of birth of an older deceased spouse as long as a retirement subtraction had been claimed on a joint return for the tax year in which the spouse died and as long as the surviving spouse had not since remarried. A surviving spouse born after 1945 who had reached the age of 67 and had not remarried could elect to take the greater of the standard deduction against all types of income or the retirement income deduction based on the date of birth of the older deceased spouse.

Treatment of retirement income under PA 4.

PA 4, the Lowering MI Costs Plan, signed into Michigan law on March 7, 2023, amended (in part) Mich. Comp. Laws Ann. § 206.30, to phase out (roll back) the 3-tier system of limitations and restrictions placed on the retirement subtraction since 2012. This change provides taxpayers more options to choose the best taxing situation for their retirement benefits.

Effective date of PA 4.

PA 4 takes effect on February 13, 2024. However, as it relates to the retirement deduction options, once effective, PA 4 applies to tax years beginning in 2023.

Changes made to deduction limits by PA 4.

PA 4 amends limits on the subtraction of retirement income that are based on year of birth and age in the tax year are rolled back over a 4-year period beginning in 2023 (in other words, retirement income taxation is reduced over a phase-in period) except for certain public safety officers and employees, who may fully deduct retirement income beginning in year 2023.

PA 4 enacted two new subsections, Mich. Comp. Laws Ann. § 206.30(10) and Mich. Comp. Laws Ann. § 206.30(11). Over a 4-year period beginning in 2023, Mich. Comp. Laws Ann. § 206.30(10) phases out the deduction limits previously implemented in 2012. Mich. Comp. Laws Ann. § 206.30(10) maximums remain subject to the limiters in Mich. Comp. Laws Ann. § 206.30(1)(f)(iv) and must, therefore, be reduced by any public, military, Michigan National Guard, and railroad retirement deductions. The impact of Mich. Comp. Laws Ann. § 206.30(10) of PA 4 on the various age groups is summarized below:

• PA 4 does not impact taxpayers born before 1946 (Tier 1 taxpayers under PA 38). The retirement subtraction for these retirees continues to be unlimited for all retirement or pension benefits received from public sources. These retirees must still reduce the maximum allowable subtraction for any private retirement by any public retirement subtraction. Public retirement in this context refers to federal retirement or pension or retirement or pension issued by the State of Michigan, as well as military pensions, railroad retirement pensions, and Michigan National Guard pensions.
• Tax Year 2023 – Taxpayers born after 1945 and before 1959 may deduct combined public and private retirement benefits not to exceed 25% of the inflation-adjusted private retirement maximum under Mich. Comp. Laws Ann. § 206.30(1)(f)(iv). (For 2023, this limit is $61,518 for single and married filing separate filers and $123,036 for joint filers, 25% of which are $15,380 and $30,759, respectively.)
• Tax Year 2024 – Taxpayers born after 1945 and before 1963 may deduct combined public and private retirement benefits not to exceed 50% of the inflation-adjusted private retirement maximum under Mich. Comp. Laws Ann. § 206.30(1)(f)(iv).
• Tax Year 2025 – Taxpayers born after 1945 and before 1967 may deduct combined public and private retirement benefits not to exceed 75% of the inflation-adjusted private retirement maximum under Mich. Comp. Laws Ann. § 206.30(1)(f)(iv).
• Tax year 2026 and each year thereafter – Regardless of year of birth, taxpayers may deduct combined public and private retirement benefits up to the inflation-adjusted private retirement maximum under Mich. Comp. Laws Ann. § 206.30(1)(f)(iv). The inflation-adjusted limit does not apply to taxpayers born before 1946 because Mich. Comp. Laws Ann. § 206.30(10) is elective, and these Tier 1 taxpayers may still elect to take an unlimited deduction for all retirement or pension benefits received from public sources under Mich. Comp. Laws Ann. § 206.30(9)(a).

If a subtraction using the limitations above is claimed on a joint return for the year a spouse died and the surviving spouse has not yet remarried, the surviving spouse may use the phaseout method based on the older deceased spouse’s year of birth and subject to the limitations applicable to a single filer return.

PA 4 also added Mich. Comp. Laws Ann. § 206.30(11), carving out a population of taxpayers who are not subject to the 4-year rollback of the deduction limits. Instead, beginning in tax year 2023, Mich. Comp. Laws Ann. § 206.30(11) restores a full deduction of any public retirement income, to the extent a qualifying distribution is included in AGI, for these retirees. However, any public retirement deduction claimed reduces the maximum private retirement deduction. This subsection applies to retirees receiving retirement or pension benefits from services provided as an employee of a public police or fire department, a state police trooper, a state police sergeant, or a corrections officer employed by a county sheriff in a county jail, work camp, or other facility maintained by a county that houses adult prisoners.

The provisions of Mich. Comp. Laws Ann. § 206.30(10) and Mich. Comp. Laws Ann. § 206.30(11) are elective. Taxpayers may choose the maximum deduction available under either provision, if applicable, or under Mich. Comp. Laws Ann. § 206.30(9) (the provisions that went into effect under PA 38).