Subsequent legislation ruins pension tax

Subsequent legislation ruins Michigan's pension tax

June 22, 2020

In the original pension tax legislation (Public Act 38 of 2011, effective for the 2012 tax year), there were 3 "tiers" of retirees depending on age:

Born before 1946: No tax on pensions
Born 1946-1952: $20,000 pension exemption for single filers, $40,000 for joint filers
Born after 1952: No pension exemption

It wasn't long before Public Act 597 of 2012 came along giving a larger tier 2 exemption to retirees whose pensions were from an agency not covered by the Social Security Act. The exemption is $35,000 for a single filer, $55,000 for joint filers, and $70,000 for joint filers if both spouses worked for the “uncovered” agency. The bill also added a pension exemption for tier 3 retirees not covered by the Social Security Act. Retirees born after 1952 whose age was 62-66 got a $15,000 exemption on a single return, $15,000 on a joint return and $30,000 for joint filers if both spouses worked for the “uncovered” agency. Here is the bill showing the changes. (It also exempted pensions received for services in the Michigan National Guard.)

Who are these retirees whose pensions are from an agency not covered by the Social Security Act? For the most part, police and firefighters. This is from the MI-1040 instructions, page 15:

The most common instances of pension and retirement benefits from employment that is not covered by Social Security are police and firefighter retirees, some federal retirees covered under the Civil Service Retirement System and hired prior to 1984, and a small number of other state and local government retirees. Federal retirees hired since 1984 and those covered by the Federal Employees’ Retirement System are covered under the SSA.

For most local governments, police and fire pensions comprise the bulk of pensions paid, so the special exemption for retirees whose employment was not covered by the Social Security Act took a big chunk out of the savings expected from the phase-out of the pension exemption.

The idea behind the exemption for these retirees is that they they are deprived of Social Security benefits, so they need the exemption to make up the loss. But they also do not pay in to the system. The Social Security tax is 12.4% of earned income up to an annual total of $137,700, with the employee paying 6.2% and the employer paying the other 6.2%. (source) It is generally believed that the average total benefit received is more than the amount paid in, but the difference is not that great, as this story from PolitiFact says.

The other problem with deprivation of Social Security benefits argument is that it is also used to justify extra- generous pensions.

The legislature wasn't done messing with the pension tax. Public Act 149 of 2017 extended the tier 2 exemption for retirees whose pensions are from an agency not covered by the Social Security Act ($35,000/$55,000/$70,000) to tier 3 retirees, but only for those who retired as of January 1, 2013. Anyone retired after that got the $15,000/$30,000 exemption when they were age 62-66, but otherwise nothing. Here is the bill showing the changes.

The House Fiscal Agency analysis of the bill identifies the beneficiaries of the changes:

The analysis also addresses the inequities:

Not only did it treat retirees inequitably depending on retirement age, it took another big chunk out of the savings expected from the pension tax.

This chart summarizes the pension exemption:

Covered by Social Security Act

Not covered by Social Security Act

Born between

1946-1952

Exemption limited to $20,000 on a single return and $40,000 on a joint return.

After age 67, the exemption is applied to all income, but if taken, military income (compensation and pension) and railroad retirement/ Michigan National Guard pension exemptions must be given up.

Exemption limited to $35,000 on a single return, $55,000 on a joint return and $70,000 for joint filers if both spouses worked for the “uncovered” agency.

After age 67, the exemption is applied to all income, but if taken, military income (compensation and pension) and railroad retirement/ Michigan National Guard pensions are no longer exempt.

Born after 1952

Before age 67: no exemption

After age 67: $20,000/$40,000 deduction applied to all income, but if taken, social security benefit exemption and personal exemptions must be given up.

Retired as of January 1, 2013: Exemption limited to $35,000 on a single return, $55,000 on a joint return and $70,000 for joint filers if both spouses worked for the “uncovered” agency.

Retired after December 31, 2012, age 62-66: $15,000 pension deduction on a single return, $15,000 on a joint return and $30,000 for joint filers if both spouses worked for the “uncovered” agency.

All others, no pension exemption.

The above chart is mine. Treasury has its own version.

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