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Most police and firefighters avoid pension tax June 17, 2020
Most retired police and firefighters in Michigan don't pay income tax on their pensions. The so-called pension tax hardly touches them.
That's not the case for other younger retirees. Those born after 1952 get no pension exemption at all - they pay tax on their entire pension. Retirees born between 1946 and 1952 get no specific pension exemption, but they are eligible for the standard deduction, which is $20,000 on a single return and $40,000 on a joint return. Pensions for retirees born before 1946 are entirely exempt.
The reason most police and firefighters don't pay is that there are special pension exemptions for retirees who worked for an agency not covered by the Social Security Act.
I wasn't able to find any information on which groups in Michigan are not covered by Social Security, but I know that Lansing's police and firefighters are not and Eaton County Sheriff officers are.
The exemption is $35,000 for the single filer, $55,000 for joint filers and $70,000 for joint filers if both spouses worked for the “uncovered” agency. That is pretty generous compared to the $20,000/$40/000 standard deduction. My wife and I get pretty good state pensions, but the total taxable amount reported to the IRS is only $47,661, well below the $55,000 exemption for joint filers who are not covered by Social Security.
This special exemption for retirees whose jobs weren't covered by the Social Security Act was not part of the original legislation phasing out the pension exemption. That was Public Act 38 of 2011, signed by Governor Rick Snyder on May 25, 2011 and effective for the 2012 tax year. Another bill signed by Snyder on January 8, 2013 - Public Act 597 of 2012 - exempted pensions received for services in the Michigan National Guard (effective January 1, 2012) and enacted - effective January 1, 2013 - the special exemption for retirees who don't get Social Security.
For most local governments, police and fire pensions comprise the bulk of pensions paid, so the special exemption takes a big hunk out of the tax savings initially expected from phase-out of the pension exemption. In Lansing, pensions paid in January 2020 to police and fire retirees totaled $2,847,047.66 while pensions paid to other retired City employees totaled $2,017,307.65.
The philosophy behind the exemption for these retirees is that they they are deprived of Social Security benefits, so they need the exemption to make up for 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 that 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.
Tax treatment of pensions is much more complicated than I've made it sound here, but after studying the subject until my eyes crossed, I think I've got it right. If you want to look for yourself, there is the 2-page Michigan Pension Schedule (Form 4884) that is used to calculate the "retirement and pension benefits subtraction" for your tax return. Line-by-line instructions are on pages 19-20 of the MI-1040 Book. There is also this Income Tax for Retirement Benefits chart that shows that even an attempt at simple explanation turns out to be clear as mud.
Send comments, questions, and tips to stevenrharry@gmail.com or call or text me at 517-730-2638. If you'd like to be notified by email when I post a new story, let me know.
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