Michigan: Explanation of reciprocal tax agreement requirements

Reciprocal tax agreements do not get much attention in the media, but they matter a lot to the people whose income tax liabilities they affect.  For example, New Jersey’s governor, Chris Christie, left citizens in New Jersey and Pennsylvania dangling angrily for months last year as he publicly toyed with the idea of withdrawing from the PA/NJ Reciprocal Income Tax Agreement, a deal that had been in place between those two states for four decades.

Eventually, in September, Gov. Christie announced that he had decided to terminate the agreement, effective Jan. 1, 2017. At the time, he blamed unfunded pension obligations of $80 billion, though the Garden State was also experiencing other budget difficulties that made it difficult to give up the revenue. The announcement drew immediate scorn from various stakeholders, including Pennsylvania’s Gov. Tom Wolf, who castigated Gov. Christie for costing Pennsylvanians an extra $5 million annually. 

However, in November, NJ.com reported that amid the outrage, Gov. Christie had changed his mind. He claimed that New Jersey could save $200 million in a public worker union-backed health care bill that modified the state's pharmacy benefits system. This covered the $180 million that New Jersey stood to gain had it terminated the Agreement.

Michigan is another state that is party to a number of reciprocal agreements seeking to prevent income from being subject to income tax in more than one state when an employee lives in one jurisdiction but works in another. Under Michigan’s law in particular, when an individual lives in a state that exempts a Michigan resident from paying income taxes in that state, the Michigan Department of Treasury is entitled to enter into a reciprocity agreement with that state, to provide a similar tax exemption for that state’s residents on income earned in Michigan.

Pursuant to these arrangements, the department has issued Revenue Administrative Bulletin 2017-13. This bulletin replaces the previous one, from 1988, and updates the information pertaining to the state’s reciprocal agreements currently in effect.

The states that have entered into reciprocal agreements with Michigan include:

• Wisconsin (effective Oct. 1, 1967)
• Indiana (effective Jan. 1,  1968)
• Kentucky (effective Jan. 1, 1968)
• Illinois (effective Jan. 1, 1971)
• Ohio (effective Jan. 1, 1972)
• Minnesota (effective Jan. 1, 1984)

Under the general terms of each reciprocal agreement, a Michigan resident is exempt from any income tax imposed by a reciprocal state on compensation earned for personal services performed in the reciprocal state. This compensation is limited to salaries, wages and commissions.

Similarly, a resident of a reciprocal state who earns compensation for services performed in Michigan is exempt from Michigan income tax. The resident of a reciprocal state need not file a Michigan income tax return if he or she has no income subject to tax in Michigan. Reciprocal agreements do not apply to independent contractors, local taxes, or income other than compensation.

Certain requirements apply to Michigan employers, and Michigan residents who earn their income in other states. With respect to Michigan employers, the general rule is that they must withhold income tax from all compensation paid to nonresident employees for work done in Michigan. However, if there is an agreement in place, the employer must either create or develop a form containing specific information about the employee whose income is to be exempted, including the name, legal address, and Social Security number, and in turn, use that document as its authority to not withhold Michigan income tax. 

With respect to a Michigan resident who earns their income outside of the state, they may ask their employer to voluntarily withhold Michigan income taxes pursuant to its voluntarily registration with the Michigan Department of Treasury.  Alternatively, if the employer does not withhold the tax, the employee must pay quarterly estimates if they expect their annual tax liability to exceed $500. Thereafter, the employee may file a return in Michigan to claim a refund of the taxes erroneously withheld and remitted, paying attention to the appropriate statute of limitations.