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Michigan Tax Changes to Pension and Retirement Benefits in 2012

December 15, 2011

Published in December 2011 in Business Update

By David Barrons, CPA, Multi-State Tax Partner

Over the next couple of months, Michigan taxpayers receiving pension and retirement benefits may be surprised to receive a request to complete Withholding Certificate Form MI W-4P from the pension or retirement administrator of their plan. This is a direct result of the significant changes to Michigan's Individual Income Tax that take effect January 1, 2012 and includes the taxation of certain pension and retirement benefits. Under the new law, entities that disburse pension or annuity payments may be required to collect state withholding on this payments that are expected to be included in taxable income of the recipient at a rate of 4.35%, unless the taxpayer is exempted under one of the provisions on Form MI W-4P. If Michigan does not have jurisdiction over the entity disbursing the payments there will be no requirement to withhold. However, this does not relieve the taxpayer from making Michigan estimated tax payments if there is an expected tax liability.

In part, the Michigan taxability of pension and retirement benefits will be based on the year of birth of the taxpayer. For taxpayers that were born before 1946, there is no change in 2012 regarding the tax treatment of pension and retirement benefits. For those taxpayers born after 1945, the Michigan tax treatment of pension and retirement benefits will be determined by age group; taxpayers born between 1946 and 1952 subjected to one section of the law; and, taxpayers born after 1952 subjected to different section of the law. Depending on their date of birth, three individuals receiving the same income could be taxed three different ways.

This significant change to Michigan tax law was intended to address the growing reality in Michigan; we are an "aging" state. Individuals that have retired or those that receive retirement or pension payments make up an ever increasing proportion of the population. This is not a result of our sunny and warm winters but is due to the loss of over 1 million jobs in the last decade and the flight of individuals seeking jobs in other states. Individual income tax revenues would continue to decline unless some action was taken. The change was also a direct result in the elimination of a significant portion of the business tax burden through the elimination of the MBT in the hopes of eventually attracting more jobs to Michigan.

One would think that tax treatment based on the year of birth would be subject to some legal challenge as possibly unequal treatment before the law. In fact, the Snyder Administration wanted to resolve this issue prior to the Law taking effect. It petitioned the Michigan Supreme Court to rule as to whether the new law regarding the tax treatment of pensions and retirement payments was fair in the eyes of the Court. To date, the Michigan Supreme Court has not issued its decision on whether the law as written passes Federal and Michigan Constitutional questions, including equal protection concerns as well as a violation of the graduated income tax prohibition. Several groups have lined up challenging and supporting the law as currently enacted. If the issue is not resolved before year end, the Law will take effect in its current form on January 1, 2012. 

No matter what age bracket a taxpayer falls in, it is a good time to evaluate tax planning for 2012 and beyond. There are other significant changes to the Michigan Individual Income Tax that effect all taxpayers. These changes could impact withholding or the need for estimated tax payments in 2012.