THE TAX ATTIC with Jerry Coon

Supreme Court rules pensions taxable

Jerry Coon

The Michigan Supreme Court on Friday, Nov. 18, upheld the constitutionality of the controversial Michigan pension tax changes made by our legislature last spring. Public Act 38, as signed by Governor Snyder, proposed taxing public pensions beginning on January 1, 2012.

Private pensions have always been taxed, but public pensions paid to retired school, federal and state workers have not previously been taxed. The Act placed public and private pensions in the same pot and proposed taxing all of them at the same rate. However, there was some question as to whether the legislature had the power to levy a tax on those public pensions.

Hence, the Michigan Supreme Court became involved in this sticky matter. It was asked to decide five issues.

1. Does or does not taxing public pensions “impair accrued financial benefits of a pension plan retirement system of the state…”? The pension recipients were promised a certain level of financial benefit upon retirement. Does taxing those pensions now reduce or impair that financial benefit?

2. Does or does not taxing public pensions “impair a contractual obligation in violation of the Michigan Constitution…”? Did the state have a Constitutional contract with the pension recipients to provide a promised level of pension benefit that would be reduced by the amount of tax incurred?

3. Does or does not taxing all pensions differently based on the date of birth “violate the equal protection of the law under the Constitution…”? People born before 1946 would pay no additional tax, so they were held harmless by the Legislature. People born between 1946 and 1952 would be impacted somewhat, while those born after 1952 would be extremely impacted by the bill. Is this legal?

4. Does or does not taxing all pensions differently based on the taxpayer’s total household resources “create a graduated income tax in violation of the Constitution…”? Michigan is a flat-tax state. Everyone pays at the same tax rate on their Michigan taxable income. The proposed law said taxpayers with total household resources in excess of $75,000 single and $150,000 joint were not entitled to a $20,000 single or $40,000 joint pension income exemption. Was this legal?

5. If the Supreme Court holds any part of the act as unconstitutional, does it make the entire law unconstitutional?

By a 4-3 ruling, the Supreme Court, with one exception, ruled in favor of the Legislature and Governor Snyder.

1. It ruled that taxing public pensions does not impair the accrued financial benefit promised to the recipients.

2. It ruled that taxing public pensions does not impair a contractual obligation of Michigan.

3. It ruled that it is legal to tax pensions based on the age of the recipients.

4. However, it did rule that it was not legal to tax people differently based on total household income. Michigan was indeed creating a graduated income tax when they proposed phasing out the $20,000/$40,000 exemption based on having household resource income of $75,000/$150,000.

5. Finally, it ruled that because one provision of the bill was not legal, throwing out that one provision did not make the entire law unconstitutional.

This was a victory for the Legislature and Governor Snyder of gigantic proportions. Taxing public pensions was the very foundation of the revisions instituted last year. Due to this victory, I am sure the governor joyfully celebrated the Thanksgiving holiday.

Now that the Supreme Court has ruled that pensions will be taxable, taxpayers will be receiving a MI W-4P from the pension provider. The MI W-4P is used to inform the pension provider how much Michigan tax must be withheld from the pension check.

In light of the Supreme Court’s ruling that the $75,000/$150,000 household income phase-out is unconstitutional, it appears that the form will be amended. I am sure the people in the forms department are working feverishly to implement an amended form throughout the entire system. It may even have been a working holiday for them.

In any event, the MI W-4P must be completed and sent back to the provider. If it is not sent back, the pension provider must presume that the pension is all taxable and, therefore, withhold tax at the rate of 4.35%. By checking the appropriate box on the form, taxpayers can declare that they were born before 1946, which basically tells the provider that the pension is nontaxable to Michigan; or taxpayers can declare they were born between 1946 and 1952, which makes the first $20,000 of pension nontaxable for singles and $40,000 for joint filers; or can declare they were born after 1952, which makes the pension all taxable.

We are getting many calls about properly preparing the form. Taxpayers with questions should contact a tax professional to help with the process. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns
Action Tax Service in Rockford. Contact Jerry

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