Revenue Administrative Bulletin 1988-22

Approved: May 27, 1988

INDIVIDUAL INCOME TAX - INDIVIDUAL RETIREMENT ACCOUNTS (IRA)

RAB-88-22. This Bulletin is issued to announce the Michigan income tax treatment of contributions made to an individual retirement account (IRA) and the treatment of subsequent distributions of these amounts. This Bulletin supersedes Income Tax Bulletin 1984-4, dated April 4, 1984.

Background

Previously, the Department allowed taxpayers to claim a deduction of a distribution from an IRA as a retirement or pension benefit if the taxpayer was not a participant in a qualified plan, KEOGH, or a charitable annuity at the time the account was established.

The Department has relied on Income Tax Rules, 1979 AC, R 206.11(2), stating in part that retirement and pension benefits for the purpose of this adjustment include individual retirement plans for persons who are not participants in a qualified plan, a KEOGH plan or a charitable annuity. This Rule, when adopted, reflected the current Federal law regarding limitations on individuals establishing IRA's. However, in 1982, limitations on participation, i.e., contributions to an IRA by individuals participating in a qualified pension plan, were effectively removed.

On the basis of the foregoing, the Department concludes that any holder of an IRA account who receives distributions from that account may reduce his adjusted gross income by amounts qualifying under the Michigan Income Tax Act, MCL 206.30(f), as benefits received from a retirement or pension plan. A distribution from an IRA qualifies as a retirement or pension benefit if the distribution is not made until the participant has reached the age of 59 1/2 , except in the case of death or disability.

An amended return may be filed to claim a refund, as statutorily provided, within four years from the due date of the original return.

Federal Treatment

Contributions to an IRA

Section 219(a) of the Internal Revenue Code of 1986 provides that a employee or self-employed person may deduct an amount equal to the contributions made to an individual retirement account on his or her Federal income tax return. IRC Section 219(b) provides that the deduction shall not exceed the lesser of: (1) $2,000 ($2,250 if filing jointly and one spouse has no compensation), or (2) 100 percent of "compensation" as defined in IRC Section 401(c)(2) includable in the taxpayer's gross income in the taxable year.

The Tax Reform Act of 1986 imposes greater limits on the deduction if a taxpayer is an active participant in a tax-qualified retirement plan or government plan or has adjusted gross income in excess of the "applicable dollar amount" as defined in IRC Section 219(g).

Distributions from an IRA

Amounts from an IRA may not be withdrawn without penalty until the taxpayer has reached the age of 59 1/2 , except in case of death or disability. (See IRC Section 72(t).) Distributions will be taxed as ordinary income and includable in the taxpayer's gross income in the year received.

Michigan Income Tax Treatment

Contributions to an IRA

The Michigan Income Tax Act, MCL 206.30(1), defines Michigan taxable income as Federal adjusted gross income as determined under the Internal Revenue Code subject to certain adjustments. Contributions to an IRA by a resident of Michigan will not be taxed to the extent they are deductible in the calculation of Federal adjusted gross income.

In the case of a nonresident, the taxpayer is allowed that portion of the deduction that the taxpayer's "earned" income from Michigan sources bears to total "earned" income from all sources.

Distributions from an IRA

Resident. Generally, amounts distributed to an individual from an IRA are included in a taxpayer's Federal adjusted gross income. Distributions that qualify as a retirement or pension benefit may be deducted on the Michigan income tax return. The maximum deduction is the smaller of: (1) the distribution included in gross income, or (2) $7,500 ($10,000 on a joint return) under the Michigan Income Tax Act, MCL 206.30(1)(f)(iv). A distribution from a spousal IRA (nonworking spouse) that qualifies as a retirement or pension benefit is also deductible within the limitations described above.

A participant in the plan who is disabled before the age of 59 1/2 ) is entitled to treat the distribution as a pension or retirement benefit. A surviving spouse may claim a deduction of distributions received from an IRA to the extent the distributions qualify as pension or retirement benefits.

A premature distribution of amounts from an IRA (withdrawal before reaching age 59 1/2 is taxable to the extent the distribution is includable in Federal gross income under the Department of Treasury Income Tax Rules, 1979 AC, R 206.11(5). There is no Michigan penalty for early withdrawal from an IRA.

Nonresident. A distribution from an IRA that qualifies as a pension or retirement benefit (distributed after the participant reaches 59 1/2 years old) is allocated to a taxpayer's state of residency. A non-qualifying distribution is taxable to Michigan if the deduction was claimed on income received for personal services performed in Michigan or from self-employment activity conducted in Michigan.

When a Michigan resident has established an IRA and subsequently changes domicile to another state, Michigan will tax a premature distribution. The amount contributed to the IRA when in Michigan including interest that has accrued through the date of the domicile change is subject to Michigan Income Tax.

Resident of Reciprocal State. In accordance with the Michigan Income Tax Act, MCL 206.256(3), non-qualifying (premature) distributions from an IRA received by a resident of Ohio, Indiana, Illinois, Wisconsin or Kentucky will not be taxed by this State although the distribution was received for services performed in this State or the taxpayer was a resident of this State at the time the compensation or self-employment income was earned. Conversely, these states will not tax salaries received by a Michigan resident where the services were performed in the other state or where the taxpayer is a resident of one of these states at the time the compensation was earned. A Michigan resident is not allowed a credit for tax paid to the other state if a reciprocity agreement is in force.

Household Income

For purposes of computing a property tax credit, farmland preservation tax credit, or home heating credit, a distribution from an IRA is includable in household income only in the year the income is includable in a taxpayer's Federal adjusted gross income.

Summary

For Federal income tax purposes, the rules governing contributions to an IRA have been changed substantially for tax years beginning in 1987. Prior to the law change, an individual who was an active participant in a qualified employer retirement plan was allowed the same deduction of his or her contributions made to an IRA plan as an individual who was not an active participant in an employer plan, regardless of his or her level of income. Beginning in 1987, an employee covered by a qualified employer retirement plan will have his or her deduction of contributions to an IRA limited based on his or her level of income and filing status. [See Internal Revenue Code Section 219(g)]

For Michigan income tax purposes, qualified distributions from an IRA of an individual, whether or not this individual was covered by a qualified employer retirement plan at the time the IRA was established, are deductible within the limitations for retirement pension benefits