One of the unique conditions of living in the United States is that we live in the land of fifty-one (51) sovereigns, namely the federal government and each individual state of the union. To fund the individual operations of each government, you can be sure that there is a tax collecting and tax enforcement agency within that sovereign to guaranteed that every entitled dollar is collected. This arrangement creates special issues for residents living near state borders who reside in one state and work in another.
MCL 206.55 allows a tax credit for Michigan resident individual, estate or trust for the amount of income tax imposed on that individual, estate or trust by the following:
- Another state of the United States.
- A political subdivision of another state of the United States (e.g. the City of Toledo, Ohio imposes a 2.25% flat income tax on local income even if earned by nonresidents).
- The District of Columbia
- A province of Canada ONLY to the extent that all or a portion of the provincial tax has not been claimed as a credit for federal income tax purposes.
- Any income derived from sources outside of Michigan that is also subject to income taxes from another state, political subdivision of another state, or Canadian province.
This tax credit DOES NOT apply to the following:
- United States federal taxes of any kind (e.g. income, excise or estate taxes).
- Non-income taxes imposed by another state, political subdivision of another state or Canadian province (e.g. sales taxes).
- Canadian federal income taxes.
- Canadian provincial taxes claimed as a carryover deduction as provided by the Internal Revenue Code.
- Any Canadian provincial taxes imposed before tax year 1978.
This credit "shall not exceed an amount determined by dividing income that is subject to taxation both in this state and in another jurisdiction by taxable income and then multiplying that result by the taxpayer's tax liability before any credits are deducted." MCL 206.255(3).
The problem is that, despite the tax credit, an individual who is employed outside of his residence state may still be subject to income tax liability from both states. To prevent this issue, states may voluntarily enter into reciprocal agreements with other states to prevent income from being taxed by both entities. MCL 206.256 provides that if the laws of another state exempt a Michigan resident, estate or trust from income tax liability for personal services performed in that state, then the Michigan Department of Treasury "may enter into a reciprocal agreement with that state to provide a similar tax exemption for that state's residents on income earned for personal services performed in this state." Compensation for personal services includes wages, salaries and commissions.
Michigan has entered into reciprocal agreements with the following states:
- Wisconsin, effective October 1st, 1967.
- Indiana, effective January 1st, 1968.
- Kentucky, effective January 1st, 1968.
- Illinois, effective January 1st, 1971.
- Ohio, effective January 1st, 1972.
- Minnesota, effective January 1st, 1984.
The reciprocal agreements only apply to the income taxes imposed at the state level. They DO NOT apply to the following:
- Independent contractors for whom income withholding is not required.
- Income taxes imposed by a political subdivision of another state (e.g. city and township).
- Taxes on income that is not derived from compensation for personal services (e.g. capital gains taxes).
Generally, Michigan employers must withhold taxes on all compensation paid to employees for work performed in Michigan, even if that employee is a non-resident. However, if there is a reciprocal agreement in effect, that employer may develop a form or document containing information from the non-resident employee as authority that Michigan income tax does not have to be withheld. Likewise, a Michigan resident working for an employer in a reciprocal state may ask his or her employer to voluntarily withhold Michigan income taxes. That out-of-state employer may register for withholding with the Michigan Department of Treasury, but is not required to. If Michigan income taxes are not withheld, then that employee may have to pay quarterly estimated taxes to the Department of Treasury if the state income tax liability for the year is expected to exceed $500.00.
If you have further questions about Michigan taxation or you need legal assistance in a state collection or enforcement action, do not hesitate to contact the experienced attorneys at Kershaw, Vititoe & Jedinak PLC.