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July 25, 2014

Michigan's New Tax and Withholding Requirements for Retirement Income

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.  

© 2014 Varnum LLP

About the Author

Larry J. Titley, Varnum Law Firm, Labor Employment Attorney
Partner

Larry is counsel to employers on employee benefit matters including pension plans, profit sharing 401(k) plans, employee stock ownership plans, and other retirement and fringe benefit programs. He works with third party administrators of employee benefit plans, trustees of multi-employer pension and health care plans, and individuals planning for retirement.

He serves as general employee benefits counsel for employers including manufacturers, banks, health care organizations and trustees of multi-employer...

616/336-6571

About the Author

Jeffrey A. DeVree, Varnum Law Firm, Labor Employment Attorney
Partner

Jeff chairs Varnum's employee benefits practice group. He has 25 years of experience working with employers, executives and third-party administrators on a wide range of employee benefit, executive compensation and individual retirement matters, including plan design, plan administration, benefit plan disputes and tax planning for retirement.

He also helps solve complex tax issues in business and investment transactions, especially those involving pass-through entities and...

616/336-6566

About the Author

Nancy L. Farnam, Varnum Law Firm, Employee Benefits Attorney
Partner

Nancy represents a wide range of employers in the design, documentation, administration and taxation of welfare benefit plans, qualified retirement plans and non-qualified deferred compensation plans.

248-567-7426

About the Author

Mary W. Manguse, Varnum Law Firm, Employee Benefits Paralegal
ERPA/Paralegal

Mary is involved primarily with the design of complex retirement plan programs and compliance with the requirements of the IRS, Department of Labor, and the Pension Benefit Guaranty Corporation. She deals with a variety of compliance issues that include plan administration, nondiscrimination testing for coverage and benefits, reports filed with governmental agencies, and plan summaries and other materials that are distributed to plan participants. In addition, Mary assists our labor attorneys in "best practices" reviews for compliance with labor laws.

616/336-6560

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