Michigan retirees run into some early software roadblocks and confusion on pension taxes

Like many Michigan retirees, John Harnois is looking forward to saving good money on his state income taxes, thanks to a repeal of the so-called "retirement tax" beginning in 2023.

Now, if Harnois could only get the tax software he has been using to reflect the key changes that apply to his pension and give him the correct tax break on his 2023 state return. If only.

Harnois was a deputy at Wayne County Sheriff's Office and began collecting a pension based on 24 years of service when he retired in 2009. He's 58, single, and has no children. His entire pension from the sheriff's office isn't subject to state income tax in 2023 — except he couldn't get his tax software to see things that way when he tried to do his taxes in mid-February.

But don't give up yet. The Allen Park retiree appears closer to getting the job done after I reached out to H&R Block and pointed out the glitch.

Many retirees, like Harnois, though, might be eager to file their state taxes soon to claim a tax refund. But they're going to need to work through some potential headaches relating to new elaborate rules for the state's tax on pensions in 2023.

The federal income tax rules relating to pensions did not change.

It's early in the tax season, thankfully, so there's time to work through the trouble spots. The filing deadline for both federal and Michigan returns is April 15. (Some taxpayers have longer. Those impacted by the severe storms and tornadoes that hit parts of Michigan last August now can wait until June 17 to file a federal return to pay what they owe. For Michigan returns, tax filers in areas affected by the severe storms can request additional time to file state tax returns and pay state tax bills, with penalties and interest waived.)

A complex tax change faces Michigan retirees

The state's pension tax relief has been well-publicized. Harnois read the stories in the newspaper nearly a year ago when Gov. Gretchen Whitmer signed legislation on March 7, 2023, to give the state's retirees a tax break and reverse a burdensome tax law put into place in 2012.

Whitmer even once held a giant check in a photo that said: "Pay to the order of Michigan Retirees." The amount on the check was $1,000 "on average."

Half a million Michigan households with pensions are expected to save an average of $1,000 a year. Much will be phased in over four years from 2023 through 2026.

This tax season is the first that retirees will be able to consider using the new Michigan tax law. We're not talking about across-the-board relief in 2023, though, and the rules remain far from straightforward.

Right now, some might not be looking at much or any of a state tax break on their pension income when they file their 2023 returns this year. More savings may be in future years in the move to "repeal the retirement tax."

Retirees are told to review the options and choose the system that works best for them, use the old state tax rules or the new tax rules that apply for 2023.

Public safety retirees get early tax break

What is clear: A large group of public safety retirees are big winners in 2023.

Beginning in 2023, a special provision allows qualified retired public police officers and firefighters, county correction officers, and state troopers and sergeants to "fully deduct, to the extent a qualifying distribution is included in AGI, retirement benefits received from Michigan service." Their tax break for their public pension isn't based on age. No limit exists for the amount of the public pension that can be deducted on the state level for these retirees.

Why one retiree waited to file his return

Harnois has been doing his own taxes for years and sat down at his computer to tackle his 2023 returns on Feb. 14, the day after the new state tax law relating to retirement benefits took effect.

"And lo and behold, it didn't work," he said.

The tax software he was using from H&R Block, he said, didn't recognize that as a qualified retired sheriff's deputy, he's able to deduct his entire pension, regardless of his age and the amount of the pension, on his 2023 Michigan income tax return. He declined to disclose the annual amount of his pension.

He went to a tax preparation place on Feb. 17, but they said their software, which was different, had issues too.

Harnois decided to wait to file. He contacted H&R Block and obtained a case number to fix the problem. He had heard nothing by Wednesday morning.

I reached out to H&R Block on Tuesday morning. I received a response Wednesday afternoon.

H&R Block has updated its software to reflect changes in the pension rules, according to an email from an H&R Block spokesperson.

But the company said it "did identify a logic rule that needed updating for a very specific situation." Yes, a situation like the one Harnois faced.

"The software is being updated today to correct that," the H&R Block spokesperson said Wednesday afternoon.

After I called Harnois with that development, he later went back into his account and he discovered that H&R Block's software was indeed fixed. He's looking at a state refund of $2,430 now, instead of around $320 when the software churned out the wrong number. He had withheld state taxes from his pension in 2023, so the refund reflects having too much money withheld given the new tax break.

Harnois said he had tried, unsuccessfully, to print out the state forms and do his state taxes by hand. He argues that the forms cannot be correct; the states says they are. Michigan retirees must work with Schedule 1 and the Michigan Pension Schedule, also known as Form 4884, to figure out their taxes.

The state's 40-page instruction booklet offers detailed instructions relating to the pension rules. But, quite frankly, those instructions can make your head spin. Yet, they are essential to read.

"The instructions direct the retiree with benefits from employment in the specified areas of public safety to complete Section A of Form 4884," according to Ron Leix, a Michigan Treasury spokesperson.

It's important, Leix said, for taxpayers to see the questionnaire in the instructions for Form 4884 for guidance about which section of the form the taxpayer should complete.

Form 4884 has been revised, he said, noting that revisions were minor, but include a new Line 6a, a box you'd check if you received qualified retirement benefits earned from service by a fire, police, or county corrections retiree. The form also has added a Section D, and annual updates to birth years and indexed dollar amounts.

The state offers a "Retirement & Pension Estimator" on its website at www.michigan.gov/taxes that can offer guidance.

Given the knotty nature of the rules, I'd guess that many taxpayers will not be able to figure out the taxes owed on their pensions without tax software. But they're also going to need to make sure they're working with software that has been updated.

Retirees shouldn't rush through their taxes

Waiting a bit here might be the right move to make for some taxpayers, according to Paul Finegold, tax partner at Baker Tilly in Southfield.

Michigan's tax change went into place on Feb. 13, he said, and some tax software being used directly by tax filers might not have been updated by early February. Several tax professionals, including Finegold, say the tax software they use has been updated.

TurboTax said it has updated its software to reflect the latest tax law relating to pensions in Michigan. "Customers have been able to prepare and file their return using these new rules since the tax year 2023 Michigan product was released at the beginning of January," according to a TurboTax tax expert, Lisa Greene-Lewis.

But early filers who did their taxes before Feb. 13 were informed when they used the TurboTax software, she said, that they could face refund delays as the Michigan Treasury delayed processing returns claiming the new retirement benefits until Feb. 13.

Retired tax filers, Finegold suggests, need to reach out to their software providers if they run into problems. Sometimes, it's a matter of figuring out what box to check.

It is best to understand the rules, though, so that you know you're getting the right number.

"I've been doing this long enough," Finegold said. "When the law changes, I don't file returns right away. I let them work out some of the kinks."

Katryna Finney, a tax manager at Andrews Hooper Pavlik in Bloomfield Hills, said her firm's software has a way to code a pension that is from a county sheriff’s office or other fully deductible source to take advantage of the special provision for 2023. She expects that others would have to code it through their software, as well.

As much of this unfolds, retirees could need to be their own "tax advocate, including studying the rules that apply to them and pushing back when necessary."

Lisa Pohl, principal and director for state and local tax for Rehmann in Grand Rapids, said taxpayers should do some research on the Michigan Department of Treasury website and familiarize themselves with changes before they meet with their preparer.

She noted that the instructions are updated. But she has heard some complaints about forms and comments that some tax preparers elsewhere are missing updates.

The state change in 2023 regarding pensions is cumbersome to calculate for private pensions. But the state isn't encouraging tax filers to wait.

The Michigan website's explainer says that "retirees can file and take advantage of the expanded retirement and pension subtraction options at the start of tax season," which was Jan. 29. But the state also noted that those returns would be processed after the new state law went into effect on Feb. 13.

Filing as soon as they have all the paperwork they need, the sited noted, "saves taxpayers time and eliminates the need or expense of filing an amended return after the law takes effect."

Even so, you want to take time to understand how some convoluted rules apply to your pension. If you make a mistake and miss the tax break, Leix said, it's recommended that you file an amended return.

For those born in 1945 or before, or those now 78 and older, there is no change. For this group, the full amount of the allowable deduction can still be deducted as it has been in the past. For the 2023 tax year, it is $61,518 for those filing single and $123,036 for those filing jointly.

Some real confusion in 2023, Finney said, hits those who are 67 years old through age 77.

For these individuals, the deduction is limited to either the Michigan standard deduction (which is $20,000 for single filers and $40,000 for joint filers) or another calculation, whichever is higher. This year, they can choose the standard deduction or take 25% of the maximum amount of the allowable deduction for those born in 1945 or before ($15,380 single or $30,759 for a married couple filing a joint 2023 return).

Unfortunately, Finney said, the calculation "isn’t as cut and dry as it sounds because the Michigan standard deduction is reduced by other deductions already taken on the return."

For example, the Michigan deduction is reduced by the personal exemption amount and any taxable Social Security benefits, military pay, military retirement benefits due to service in the U.S. Armed Forces, Michigan National Guard, or taxable railroad retirement benefits included in AGI.

"Therefore, depending on a person’s situation, the standard deduction could be reduced to zero," she said.

Younger retirees fall into a different category and could benefit from some new tax breaks for them on the 2023 return. "Recipients born after Jan. 1, 1956, through Dec. 31, 1958, may subtract qualifying retirement and pension benefits up to $15,380 if single or married filing separate, or $30,759 if married filing a joint return," according to the instructions.

Many people born in 1959 and after are not eligible for a deduction in 2023. But some might be if they received retirement benefits from employment exempt from Social Security.

Going forward, the calculation for subtracting a pension from one's state income taxes will be more generous for 2024, 2025, and 2026.

For the 2026 tax year and after, all retirees will be able to deduct their retirement or pension benefits up to 100% of a set amount that typically would have only applied to those born in 1945 and earlier. The maximum set amount changes each year.

When Harnois first began collecting his pension, he didn't pay state income taxes under the rules then. When the rules changed in 2012, he wasn't grandfathered into the old system.

A contrived, age-based system went into place after then-Republican Gov. Rick Snyder pushed through a controversial plan in Lansing to remove total and partial tax exemptions for income from public and private pensions.

When the rules changed in 2012, those born in 1945 or earlier locked in favorable tax breaks. But others saw rules based on when they were born. The tax burden didn't fall equally. It wasn't a system that was easily understood. Frankly, many thought it was a mess.

Now, unraveling the complex rules will take more time, and create much frustration this tax season. Thankfully, at least one glitch seems on the way to being fixed.

Contact personal finance columnist Susan Tompor: stompor@freepress.com. Follow her on X (Twitter) @tompor.

This article originally appeared on Detroit Free Press: New tax cut relating to pensions in Michigan has early filers stumped