Michigan Court Approves Taxing of Pensions

November 21, 2011 (PLANSPONSOR.com) - A divided Michigan Supreme Court has given approval for the State to impose a 4.35% personal income tax on pensions.

The Detroit Free Press reports the main component of the personal income tax changes — ending the blanket exemption for all public pension and most private pension income above certain thresholds — survived. However, the court unanimously struck down provisions in the new tax law that would have phased out for wealthier taxpayers the use of personal tax exemptions.   

The court found that provision, effectively raising taxes on higher income earners, is barred by the state constitutional ban on a graduated income tax, according to the news report.  

The new tax on pensions was expected to raise about $225 million in the first three quarters of 2012 and $343 million in the state’s 2012-13 fiscal year. Those numbers will be reduced by about $60 million in 2012 and $90 million in 2013 because of the court’s decision to strike down the phase-out of the personal exemption for wealthier taxpayers (those earning $75,000 and above for a single person, and $150,000 and above for couples).  

Governor Rick Snyder said he would work with the legislature to address the shortfall. Proponents of the tax exemption said they will renew pressure on lawmakers to restore them.  

The new law keeps the pension income tax exemption for retirees who will be at least 67 in 2012, and a portion of them for retirees who will be between the ages of 60-66. The court majority said taxing pension income does not violate a provision in the state Constitution that describes the pensions of state retirees as “a contractual obligation…which shall not be diminished or impaired.”  

Writing for the majority, Justice Stephen Markman said the constitutional protection of pension income is trumped by the legislature’s power of taxation, and that rescinding a tax exemption is not the equivalent of reducing the underlying benefit.  

Justice Michael Cavanagh, who wrote the dissenting opinion, said he believes the state Constitution included tax exemptions, like those previously granted to pensioners, within the definition of accrued financial benefits that could not be impaired.  

The Detroit Free press said the ruling came in response to a request by Snyder for an advisory opinion from the Supreme Court after a group of state retirees filed a challenge to the new law.