Taxation of separation payment made to nonresident

July 22, 2025

[Redacted Text]

Re: Request for Letter Ruling – Taxation of separation payment made to nonresident

Dear [Redacted Text]:

Thank you for your [Redacted Text], letter requesting a ruling on whether Michigan income tax applies to, and must be withheld from, future payments made to your client, a nonresident of Michigan, pursuant to a particular Separation and Release Agreement. As described more fully below, the agreement relates to your client’s former employment in Michigan [Redacted Text].

The Michigan Department of Treasury (“Department”), in its sole discretion, may decline to issue a letter ruling and instead issue a technical advice letter or other informal guidance if it determines that a letter ruling “is not the necessary and appropriate means to resolve or clarify the issue presented in the request.” RAB 2016-20. Because the Department has made such a determination with respect to your request, the Department is issuing this technical advice letter instead. Only the specific taxpayer identified in a technical advice letter may rely on the Department’s position stated therein and only to the extent provided in RAB 2016-20.

Facts

The facts pertinent to your request indicate that your client (“Ex-employee”) was employed as a [Redacted Text] (“Employer”) on [Redacted Text], and subsequently became a part-time Michigan resident. At [Redacted Text], the employment contract was terminated, and Ex-employee subsequently entered into a “Separation and Release Agreement” (“Agreement”). The Agreement was executed on [Redacted Text]. On [Redacted Text], Ex-employee became a nonresident of Michigan. For the [Redacted Text] tax year, Ex-employee will file a part-year Michigan Income Tax return.

Under the Agreement, Ex-employee will receive payments over several years as a [Redacted Text] The Agreement provides, in relevant part:

This Agreement shall terminate, replace, and supersede the Employment Agreement and any other prior agreements between you and the Company, whether such agreements were verbal or in writing and effective as of the Separation Date.

…

Effective [Redacted Text], the Employment Agreement and your employment pursuant thereto with Company is terminated.

…

In consideration for the release and other promises made by you as contained in this Agreement, upon the execution of this Agreement the Company shall continue to provide you, as a [Redacted Text], the following compensation in lieu – and in full replacement – of Company’s obligation to pay you the remaining [Redacted Text] (as defined in the Employment Agreement)…

The Agreement provides that the [Redacted Text] is being made “in consideration for the release and other promises.” As set forth in the Agreement’s numbered clauses, these include promises to:

• Assist with an orderly transition and [Redacted Text] related to Ex-employee’s term of employment.
• Release any claims related to Ex-employee’s term of employment or separation.
• Acknowledge that no amount is owed to Ex-employee under the employment contract.
• Cooperate with Employer regarding certain proceedings and communications.
• Agree not to engage in any disparaging conduct.
• Agree not to solicit Employer’s employees and independent contractors for a specified period.
• Return Employer’s property and maintain confidentiality.

The Agreement provides no breakdown of how the future payments are to be allocated between these obligations.

Question

You have asked:

Will Michigan income tax apply to, and must it be withheld from, future payments made by Employer to Ex-employee, a nonresident of Michigan, in connection with the Agreement?

Analysis

MCL 206.110(2) provides, in relevant part, “For a nonresident individual, estate, or trust, all taxable income is allocated to this state to the extent it is earned, received, or acquired in 1 or more of the following ways: (a) For the rendition of personal services performed in this state.” In applying this provision, the specific nature of the payment must be reviewed to determine if it was consideration for personal services performed in Michigan.

In Molter v Dep’t of Treasury, 443 Mich 537 (1993), the Michigan Supreme Court held payments from a deferred compensation plan under the Internal Revenue Code made to a former Michigan state employee who was then a resident of Florida constituted income for personal services performed in Michigan and were subject to Michigan income tax. The Court noted, for a nonresident individual, all taxable income is allocated to Michigan to the extent that it is earned or received for rendition of personal services performed in Michigan, even if those services were performed in a different year from the year the income was received:

In light of the clear legislative intent to adopt the federal approach to calculating taxable income, we conclude that the MITA authorizes taxation of income received in one year for services rendered in an earlier year, just as the IRC authorizes taxation of income received in one year but earned in an earlier year. Id. at 547 (emphasis added).

But the Court went on to distinguish the interest that was earned on the deferred compensation investments, finding it was not attributable to the performance of personal services and was not subject to Michigan income tax. Id. at 548-552. Thus, Molter instructs the Department to consider the specific nature of the income and why it was paid — i.e., for the rendition of personal services or for some other purpose — in determining whether it is taxable under MCL 206.110(2).

The Agreement indicates Ex-employee is no longer an employee of Employer and states that the employment agreement and Ex-employee’s employment was terminated [Redacted Text]. It also provides that it supersedes the employment agreement and any other agreements between Ex-employee and Employer. The payments contemplated by the Agreement appear to be consideration for complying with the Agreement’s terms, which all appear to impose duties on Ex-employee related to termination of the employment relationship, such as obligating Ex-employee to release Employer from potential claims and to engage in or refrain from specified future actions. As such, the payments do not appear to be deferred payment of wages for work performed in Michigan under the employment contract.

Because it appears from the terms of the Agreement that the separation payments are not attributable to personal services performed in Michigan but are made as consideration for various releases and post-employment obligations, the payments are akin to the interest income in Molter, i.e., non-personal-services income of a nonresident. As such, they would not be subject to Michigan income tax. [Redacted Text].

If I can be of further assistance, please feel free to contact me at (517) 335-7478.

Sincerely,

/s/ David Foos

Administrator

Direct Taxes Division

Bureau of Tax Policy