by Peter G. Pupke
The Michigan Department of Treasury has issued a release that summarizes the Michigan income tax treatment of retirement and pension benefits effective for tax year 2022. The Department has revised a chart that shows the Michigan individual income tax treatment for pension and retirement benefits effective for tax year 2022. (2022 Retirement & Pension Information, Mich. Dept. Treas., 01/01/2023; Income Tax for Retirement Benefits Effective for Tax Year 2022, Mich. Dept. Treas., 01/01/2023.)
Retirement and pension benefits under Michigan law.
Under Michigan law, retirement and pension benefits include most payments that are reported on a Form 1099-R for federal tax purposes. This includes defined benefit pensions, IRA distributions, and most payments from defined contribution plans. Retirement and pension benefits are taxable based on date of birth (see age groups herein). Regardless of date of birth, the following are not taxed:
- U.S. military pensions.
- Michigan National Guard pensions.
- Social security.
- Railroad benefts.
- Rollovers not included in federal adjusted gross income (AGI).
Subtraction allowed for qualified distributions.
A subtraction is allowed on the Michigan return for qualifying distributions from retirement plans. Retirement plans include private and public employer plans, and individual plans such as IRAs. To be considered a qualified distribution for the subtraction, several requirements must be met. For employer plans, an employee must have retired under the provisions of the plan, the pension benefits must be paid from a retirement trust fund, and the payment must be made to either the employee or a surviving spouse. (Payments made to a surviving spouse are only deductible if the employee qualified for the subtraction at the time of death.) For qualifying distributions, there may be a limitation on the amount of the exemption that can be claimed.
Distributions that do not qualify for a subtraction.
Certain distributions reported on Form 1099-R are not retirement or pension benefits. Under Michigan law, deferred compensation is taxable. These distributions include: all distributions from 457 plans; distributions from 401(k) or 403(b) plans sourced to employee contributions and the earnings from those contributions if they were not matched by the employer; and early distributions under the terms of the retirement plan are always taxable regardless of the date of birth of the taxpayer. (See retirement codes for Form 1099-R herein.)
When considering the pension subtraction, “surviving spouse” means the deceased spouse died prior to the current tax year (for example, when filing a 2022 return the spouse died in 2021). Deceased spouse benefits do not include benefits from a spouse who died in 2022. If a taxpayer or the taxpayer’s spouse received pension benefits from a deceased spouse, taxpayers should consult the Form 4884 (Michigan Pension Schedule) instructions.
Form 1099-R distribution codes.
Qualification for a subtraction is a two-step process. Taxpayers should use the distribution chart to determine whether their retirement and/or pension benefits qualify as a subtraction (step one). Taxpayers should then use the appropriate age category (step two). A taxpayer must meet both qualification requirements in order to be eligible for a retirement and/or pension benefits subtraction. If a taxpayer does not qualify based on the distribution chart in step one, then the taxpayer does not have a qualified subtraction and step two is not applicable. Form 1099-R reports the total retirement and pension benefits a taxpayer received during the year. Taxpayers should refer to box 7 on Form(s) 1099-R for the distribution code(s) that describes the condition under which the retirement or pension benefit was paid. The following chart lists distribution codes and describes eligibility of benefits for subtraction based on each code. Some exceptions exist. If a taxpayer’s distribution code is not included in the following list or if the taxpayer has questions on eligibility of his or her benefits, the taxpayers should consult their tax professional.
- Code 1, “Early distribution, no known exception.” This code indicates that the distribution is not eligible for the Michigan tax exemption.
- Code 2, “Early distribution, exception applies.” This code indicates that the distribution is not eligible for the Michigan tax exemption, unless part of a series of mainly equal periodic payments made for the life of the employee or the joint lives of the employee and their beneficiary; or early retirement under the terms of the plan.
- Code 3, “Disability.” This code indicates that the distribution is eligible for the Michigan tax exemption.
- Code 4, “Death.” This code indicates that the distribution is eligible for the Michigan tax exemption for surviving spouse only and only if the decedent would have also qualified for a normal distribution under Distribution Code 7 at the time of death. This code indicates that the distribution is not eligible for the Michigan tax exemption for all other beneficiaries. This code also indicates that the distribution is not eligible for the Michigan tax exemption if paid as a death benefit payment made by an employer but not made as part of a pension, profit sharing, or retirement plan.
- Code 5, “Prohibited transaction.” This code indicates that the distribution is not eligible for the Michigan tax exemption.
- Code 6, “Section 1035 exchange” (the exchange of life insurance). This code indicates that the distribution is not eligible for the Michigan tax exemption.
- Code 7, “Normal distribution.” That is, a normal distribution from a plan; a distribution from a traditional IRA, if the participant is at least 59-1/2; a Roth conversion if the participant is at least age 59-1/2; and a distribution from a life insurance, annuity, or endowment contract (must be age 65 and part of a series of mainly equal periodic payments made for the life of the employee or the joint lives of the employee and their beneficiary). This code indicates that the distribution is eligible for the Michigan tax exemption (limited based on age and year of birth). However, a taxpayer may not subtract distributions from a plan that: allows the employee to set the amount of compensation to be deferred; or does not prescribe the retirement age or years of service.
- Code 8, “Excess contribution plus earnings/excess deferrals (and/or earnings) taxable in 2022.” This code indicates that the distribution is not eligible for the Michigan tax exemption.
- Code 9, “Cost of current life insurance protection.” This code indicates that the distribution is not eligible for the Michigan tax exemption.
Recipients born before 1946.
For 2022, a taxpayer may subtract all qualifying retirement and pension benefits received from public sources, and may subtract private retirement and pension benefits up to $56,961 if single or married filing separately or up to $113,922 if married filing jointly. Private subtraction limits must be reduced by public benefits subtracted. Withholding will only be necessary on taxable pension payments (private pension payments) that exceed the pension limits stated above for recipient born before 1946.
Taxpayers must complete Form 4884. Military pensions, Michigan National Guard pensions and railroad retirement benefits are entered on Schedule 1, Line 11. These continue to be exempt from tax. They must be reported on Schedule W Table 2, even if no Michigan tax was withheld. Social security benefits included in a taxpayer’s AGI are entered on Schedule 1, Line 14 and are exempt from tax. Public pensions can include benefits received from the federal civil service, State of Michigan public retirement systems and political subdivisions of Michigan. Rollovers not included in federal AGI will not be taxed in Michigan. The subtraction for dividends, interest, and capital gains is limited to $12,697 for single filers and $25,394 for joint filers, less any deductions for retirement benefits including U.S. military, Michigan National Guard, and railroad retirement benefits.
Recipients born during the period January 1, 1946 through December 31, 1952.
If the older of the taxpayer or the taxpayer’s spouse (if married filing jointly) was born during the period January 1, 1946 through December 31, 1952, and reached the age of 67, the taxpayer is eligible for a deduction against all income and will no longer deduct retirement and pension benefits. Such taxpayers must complete Schedule 1, Line 24 instead of Form 4884.
The deduction is $20,000 for a return filed as single or married, filing separately, or $40,000 for a return filed as married, filing jointly. If the taxpayer checked either SSA Exempt box 23C or 23G from Schedule 1, the deduction is increased by $15,000. If the taxpayer checked both boxes 23C and 23G, the deduction is increased by $30,000.
The standard deduction is reduced by military pay (included on Schedule 1, Line 14), military, and/or railroad retirement benefits (both reported on Schedule 1, Line 11).
A surviving spouse who meets all of the following conditions may elect to take the larger of the retirement and pension benefits deduction based on the deceased spouse’s year of birth (deceased spouse must be the older of the two) subject to the limits available for a single filer or the survivor’s Michigan Standard Deduction: (1) reached the age of 67; and (2) not remarried; and (3) claimed a subtraction for retirement and pension benefits on a return jointly filed with the decedent in the year they died.
Recipients born after 1952.
All retirement (private and public) and pension benefits are taxable to Michigan, unless one of following applies:
- Taxpayers born January 1, 1953 through January 1, 1956 should not file Form 4884. Instead, taxpayers may be eligible for a Tier 3 Michigan Standard Deduction. This deduction is up to $20,000 for a return filed as single or married filing separately, or up to $40,000 for a married filing jointly return. Exemption(s) claimed on MI-1040, Lines 9a and 9d, taxable social security benefits, military compensation (including retirement benefits), Michigan National Guard retirement benefits and railroad retirement benefits included in AGI may reduce the amount eligible to be claimed on this line. To ensure the taxpayer receives their maximum deduction, taxpayers should complete Worksheet 2 in the MI-1040 booklet for Tier 3 Michigan Standard Deduction on Schedule 1, Line 25. A surviving spouse who meets all of the following conditions may elect to the take the larger of the retirement and pension benefits deduction based on the deceased spouse’s year of birth (deceased spouse must be the older of the two) subject to the limits available for a single filer or the survivor’s Michigan Standard Deduction: (1) reached the age of 67; and (2) not remarried; and (3) claimed a subtraction for retirement and pension benefits on a return jointly filed with the decedent in the year they died.
- The older of the taxpayer or the taxpayer’s spouse (if married filing jointly) was born on or after January 1, 1956 but before January 2, 1961, has reached age 62 and received retirement benefits from employment exempt from social security. The taxpayer may be eligible for a retirement and pension subtraction of $15,000. If both spouses on a joint return qualify, the maximum subtraction increases to $30,000.
- The older of the taxpayer or the taxpayer’s spouse (if married filing jointly) was born on or after January 1, 1956, received retirement benefits from employment exempt from social security, and were retired as of January 1, 2013. The taxpayer may subtract up to $35,000 in qualifying retirement and pension benefits if single or married filing separately, or $55,000 if married filing a joint return. If both spouses on a joint return qualify, the maximum subtraction increases to $70,000.
Nontaxable benefits: Military pensions, Michigan National Guard pensions and railroad retirement benefits are entered on Schedule 1, Line 11. These continue to be exempt from tax. They must be reported on Schedule W Table 2, even if no Michigan tax was withheld. Social security benefits included in the taxpayer’s AGI are entered on Schedule 1, Line 14 and are exempt from tax. Rollovers not included in federal AGI will not be taxed in Michigan.
Surviving spouse: If a surviving spouse claimed a subtraction for retirement and pension benefits on a return jointly filed with the decedent in the year they died and the surviving spouse has not remarried, then the surviving spouse may claim the retirement and pension benefits subtraction that would have applied based on the year of birth of the older of the surviving spouse or the deceased spouse.
Retirement and pension benefits chart.
The Department has also revised a chart that shows the Michigan individual income tax treatment for pension and retirement benefits effective for tax year 2022. The chart covers the tax treatment of pension and retirement benefits for taxpayers born before 1946 (Tier 1); taxpayers born 1946 through 1952 (Tier 2); and taxpayers born after 1952 (Tier 3). For Tier 2 and 3 taxpayers, the chart also shows the treatment of pension and retirement benefits before the taxpayer reaches age 67 and after the taxpayer reaches age 67.
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