What Happened?

As a reminder, Michigan enacted a law allowing individuals to claim state income tax deductions for qualified tips and qualified overtime compensation for tax years 2026 through 2028. The law also limits non-resident deductions to tips and overtime tied to services performed in Michigan.

The law was approved on October 7, 2025, and took effect immediately.

Overview

• State deduction window (Michigan): Tax years 2026–2028 (i.e., tax years beginning after December 31, 2025, and before January 1, 2029).

• What is deductible (Michigan): An amount equal to the federal deductions claimed for:
  • Qualified tips, and
  • Qualified overtime compensation.

• Nonresident limitation: Nonresidents may deduct only the tips/overtime attributable to services performed in Michigan.

• Broader context in the same law: Michigan updated its reference date to the federal tax code (Internal Revenue Code) and set rules to calculate Michigan income while excluding or “freezing” certain federal provisions for state tax purposes.

Why this matters:

• Employee questions will increase. Workers in tip- and overtime-heavy roles will likely ask how the new state deduction works and when it starts and whether it affects their take-home pay (Michigan begins with tax year 2026).

• Payroll systems may need better tracking. Even if the deduction is ultimately claimed on individual returns, employers may need cleaner internal records to support accurate employee reporting and year-end documentation (especially where tips and overtime premiums must be distinguished).

• Non-resident workforce complexity. If an employer has non-resident employees working in Michigan, the law ties the deduction to Michigan-based services, which raises sourcing and documentation expectations.

Key Risks for Employers

• Miscommunication about timing and process: Employees may expect an immediate increase in take-home pay, but the benefit is generally realized on the employee’s tax return, which can lead to confusion and payroll inquiries.

• Inadequate tip tracking and reporting controls: If tips are underreported or not categorized consistently, employees may not be able to support “qualified” treatment and may attribute discrepancies to payroll.

• Overtime premium not clearly separated from base pay: If payroll systems cannot clearly identify the premium portion of overtime versus regular wages, employees may have difficulty determining what qualifies.

• Nonresident sourcing errors: For nonresidents, only tips and overtime tied to services performed in Michigan may be deducted. Weak timekeeping or location records can increase questions and disputes.

• Waiting too long for implementation guidance: The law is already in place, and additional Michigan Treasury guidance may be issued closer to implementation. Delayed preparation can lead to rushed system changes and inconsistent practices.

Additional Information

Employer Action Items

• Review payroll setup to ensure the employer can:
  • track reported tips accurately, and
  • separate overtime base pay from overtime premium.

• Review timekeeping and location practices for employees who work in multiple states (to support Michigan sourcing for nonresidents).

• Coordinate with payroll providers and tax advisors to align year-end wage reporting and employee communications with these deductions.

• Train managers in tip-heavy areas on consistent tip reporting and reinforce that accurate reporting affects employees’ tax outcomes.

Source References

• Michigan – HB 4961 – Individual Income Tax: Income; Treatment Of Certain Provisions Under The Internal Revenue Code And Revenue Distributions

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