Overview of Pension Taxation under New Law

Prepared by Ellen Hoekstra and Todd Tennis, Capitol Services, Inc.

Governor Rick Snyder has signed the pension tax legislation, HB 4361, into law as PA 38 of 2011. Retiree and labor organizations—and many individual retirees–strongly opposed this legislation. Per the Governor’s request, the Michigan Supreme Court will be reviewing the major legal issues underlying the legislation.   As finally enacted, 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%.

Frequently Asked Questions about the new pension tax:

Q: When does the new tax take effect?

A: The law will take effect for the 2012 tax year.

 

Q: How does the tax affect retirement income of different age groups?

A: Taxpayers born before 1946 will see no change from the status quo, which exempts all public pensions and social security, as well as a substantial amount of retirement income from private plans.

Taxpayers 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.

Taxpayers born in 1953 or later 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.

 

Q: What if my spouse and I are a different age?

A: The tax will be calculated based on the age of the older spouse.

 

Q: What other types of deductions or exemptions have been changed?

A: Senior citizens born after 1945 will no longer be able to deduct a portion of interest, dividends, and capital gains received.

  • Taxpayers will no longer receive an additional $600 exemption per dependent child under the age of 19.
  • Distributions from certain individual retirement accounts used to pay qualified higher education expenses will no longer be deductible.
  • Charitable contributions made from a qualified retirement plan or account will no longer be deductible.
  • The standard personal exemption will be phased-out for single taxpayers with household resources between $75,000 and $100,000, and for married couples filing joint returns with household resources between $150,000 and $200,000.
  • The additional $1,800 exemption allowed for each taxpayer age 65 and older, and each dependent of the taxpayer, will be eliminated.

 

Q: How does the bill affect the Homestead Property Tax Credit?

A: Taxpayers will no longer be eligible for the credit if the taxable value of their homestead is greater than $135,000—e.g., for a new home, if the sale value is $270,000 or more.

The credit will be phased out if total household resources are $41,000 or greater and eliminated once household resources reach $50,000; current law does not begin the phase out until household income exceeds $73,650.

The bill eliminates much of the difference in rates between seniors and other taxpayers.

Q: Given that the State Supreme Court is reviewing this legislation, what should I do?

 

A: The results of the Supreme Court review may be available before next year.  Stay posted!


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