Revenue Administrative Bulletin 1988-26

Approved:May 27, 1988

INDIVIDUAL INCOME TAX - ALLOCATION OF INTEREST INCOME

RAB-88-26. This Bulletin describes the allocation of interest income received by a part-year resident of Michigan.

Federal Treatment

Gross Income Defined

Section 61(a) of the Internal Revenue Code of 1986 (IRC) provides that a taxpayer's gross income is income from whatever source derived. Interest income is included in this definition unless specifically exempted or excluded from taxation under federal law. [IRC Section 61(a)(4)]

Cash Basis Taxpayer

A taxpayer who reports his or her income on a cash basis will include interest in gross income in the year in which the income is "constructively" or "actually" received.

Under the doctrine of "constructive receipt," a taxpayer is considered to have received income when the income is credited or made available to the taxpayer so that he or she may draw upon or use the funds without substantial limitations or restrictions. (See IRC Section 83.)

An example of income not constructively received includes interest earned on a six-month certificate that is not credited or made available to the holder without penalty before maturity. In this example, the holder's right to the income is substantially limited.

Accrual Basis Taxpayer

The doctrine of "constructive receipt" does not apply to a taxpayer who is on an accrual basis. United States Department of Treasury Regulation 1.451-1 requires that a taxpayer who uses the accrual method of accounting will include gains, profits and income in gross income in the year "... when (1) all the events have occurred which fix the right to receive such income and (2) the amount thereof can be determined with reasonable accuracy."

Sources of Interest Income

Interest income is derived from many sources. Examples of taxable interest are interest on any deposit or savings account; interest on coupon bonds; interest on an open account, a promissory note, a mortgage, a land contract, or a corporate bond or debenture; the interest portion of a condemnation award; usurious interest; interest on legacies; interest on life insurance proceeds held under an agreement to pay interest thereon; and interest on refunds of federal and state taxes.

Michigan Income Tax Treatment

Resident Taxpayer

MCL 206.113 provides that "[i]nterest and dividends are allocable to this state if the taxpayer is a resident partnership, estate or trust or individual of this state or has a commercial domicile in this state." Therefore, interest and dividends received by a Michigan resident are fully taxable to that resident to the extent the income is included in federal adjusted gross income. Also, interest earned on municipal bonds issued by another state is includable in Michigan taxable income.

Part-year Resident Taxpayer

Interest income received under the "actual" or "constructive" receipt doctrine is allocated to Michigan if it is actually or constructively received by the individual on a date that he or she is a resident of Michigan. For a cash basis taxpayer, interest paid with respect to any deposit or bank account, mortgage or land contract, bonds, debentures, etc., will be treated as constructively received on the date it was credited to a taxpayer's account unless the taxpayer actually received the interest on or before such date.

Example 1: Taxpayer A relinquished his Michigan domicile on July 1, 1986. On June 30, 1986, his savings account was credited with interest income of $1,500.00. For Michigan income tax purposes, all of the $1,500.00 of interest is allocated to Michigan. Although Taxpayer A did not withdraw any of his income while a resident of this State, he was not substantially limited or restricted to its use during the period he was a Michigan resident.

Example 2: On October 1, 1986, Taxpayer B became a Michigan resident. Interest income of $2,000.00 was accrued in her savings account on May 15, 1986. In computing Michigan taxable income, she will allocate the $2,000.00 of income to her former state of residence because the income was earned prior to becoming a Michigan resident.

Example 3: Taxpayer C sold real property on a land contract with the first installment due on July 1, 1986. She elected to report the profit from the sale on an installment basis for federal income tax purposes. On December 15, 1986, Taxpayer C relinquished her Michigan domicile. Payments of interest received from the land contract during the period she resided in Michigan are allocable to Michigan. All subsequent payments of interest will be allocable to her new state of domicile. Gain from the sale of the property is allocable to Michigan regardless of residency of the taxpayer.

Example 4: Taxpayer D owns a money market certificate that pays interest semi-annually but imposes a penalty for early withdrawal of the interest. Before the certificate matures, Taxpayer D moved to another state. For Michigan income tax purposes, the interest income is allocable to the other state because the taxpayer's rights were substantially limited or restricted to the receipt of the income prior to the certificate's maturity date.

If Taxpayer D prematurely redeems the bond before abandoning Michigan domicile, any interest credited to the bond will be taxable to Michigan. Any penalty imposed on an early withdrawal of savings is allowed as a deduction to arrive at federal adjusted gross income. The penalty is allocable to Michigan to the extent the taxpayer is a resident of Michigan when the redemption is made.