May 2011

Overview of Pension Taxation under New Law

Prepared by Ellen Hoekstra, Capitol Services, Inc.

Governor Rick Snyder has signed the pension tax legislation into law as PA 38. Retiree and labor organizations—and many individual retirees–strongly opposed this legislation, which we expect to see challenged in court.  The legislation modified the Governor’s proposal to fully tax all pensions but added another $150 million in budget reductions beyond those in the executive budget proposal.  The new law and related other legislation also signed into law specify that as of January 1, 2012, payments to retirees are subject to state income tax.  The state income tax rate remains at 4.35% until January 1, 2013 and then is reduced to 4.25%.

The new pension tax proposal has three tiers: taxpayers born before 1946, those born between 1946-1952, and those born 1953 and later. The first group would see no changes from the status quo.

The second , those born between 1946-1952, would have retirement income up to $20,000 single and $40,000 joint exempt, with income beyond that level taxed at 4.35%. Additionally, they can claim exemptions for which they are eligible and can exempt Social Security income.  However, they are not eligible for the $20,000/$40,000 exemption if they take either the Armed Forces retirement income deduction or the income deduction under the Railroad Retirement Act.

The third tier would see retirement income—except for Social Security– taxed at 4.35% until they turn 67, after which time they would qualify for a senior income exemption of $20,000 for single and $40,000 joint, regardless of income source.   Retirees in this bracket have a choice between (1) the $20,000/$40,000 exemption against all types of income, with no personal exemptions and no exemption for Social Security or (2) continuing to exempt Social Security, along with the personal exemptions for which they are eligible.   Here too they are not eligible for the $20,000/$40,000 unrestricted exemption if they elect to take either the Armed Forces retirement income or Railroad Retirement Act deduction.

For both the second and third tier, Individuals with incomes exceeding $75,000 single or $150,000 joint would not be eligible for the deductions.

The new legislation specifies that for a joint return, the limitations and restrictions are applied based on the age of the older spouse filing the joint return.  For more detailed questions, members are urged to contact their tax preparers.

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