This post has been co-authored by Merrick School of Business faculty members Phillip Korb, CPA and M. Kathryn Demarest, CPA.
Recently, Maryland Governor Larry Hogan proposed cutting income taxes for retirees. Before considering what more we need to do to reduce Maryland income taxes for this class of taxpayers, let us look at what we are already doing. First, Maryland does not tax Social Security benefits. This is in stark contrast to the fact that 13 states do tax Social Security benefits.
Furthermore, if you are 65 or over or you or your spouse was totally disabled, you are entitled to a pension exclusion. This exclusion reduces the amount of income that is taxed by Maryland and the counties and, as a result, reduces a taxpayer’s income tax obligation. The exclusion is equal to the lesser of retirement income received as a pension, annuity or endowment from an “employee retirement system,” such as a 401(k), 403(b), or a defined benefit plan, or $31,100 less taxpayer’s Social Security benefits. This provides a particular benefit to federal civil servants, police, firemen, and others who may not have been required to participate in the Social Security system or had their Social Security benefits limited by rules governing federal pensions.
There are additional benefits available to certain retirees. Retired correctional officers; law enforcement officers; and fire, rescue, or emergency services personnel may also use the pension exclusion beginning at age 55, with the provision that the retirement income must be attributable to their service in the aforementioned capacities.
One of the characteristics of a good tax system is that it is equitable. While there are many economic and social goals promoted through our tax system, the concepts of fairness and equal treatment are paramount. In order to provide equitable treatment to all retirees, the general Maryland pension exclusion should be expanded to apply to distributions from traditional IRAs and simplified employee plans (SEP) as well, not just pensions from “employee retirement systems.” If tax policy is made to encourage individuals to save for retirement, the tax law should not be written in a way to exclude those same benefits associated with retirement savings for self-employed individuals and individuals that rolled their pensions into traditional IRAs.
As if what is currently in the law benefiting retirees is not enough, Governor Hogan proposes eliminating state income taxes on retirees who make less than $50,000 per year, as well as a reduction of 50 percent to 100 percent for retirees who make less than $100,000 per year. Governor Hogan believes this change is necessary to keep tens of thousands of Maryland retirees from being forced to flee the state. Going back to fairness, why not extend this break to all taxpayers and not just retirees? Or is it because those lower earning taxpayers cannot flee Maryland because of their jobs and family?
Trying to help certain classes of taxpayers at the expense of other classes of taxpayers goes to the bigger issue, Maryland’s individual income tax is extremely regressive. Maryland’s income tax system is essential a “flat tax.” Beyond the first $3,000 of income, the tax range is from 4.75 percent to 5.75 percent. On top of this rate, local jurisdictions add an additional tax, which is collected by the state. Approximately 1/3 of local jurisdictions, including Baltimore City and County, Howard County, and Montgomery County, tax at 3.2 percent, with the remainder taxed at slightly lower rates. Adding a local tax rate of 3.2 percent to the marginal rates above results in a range of 7.95 percent and 8.95 percent. Maryland’s tax system becomes more regressive when considering deductions from income. Higher income taxpayers are able to reduce their taxable income and tax obligation through deductions such as mortgage interest, while low income taxpayers renting a home receive no benefit.
Rather than continuing to add to the numerous Maryland subtractions and credits designed to benefit certain classes of taxpayers and special interests, a fairer and simpler approach might very well be to make the Maryland individual income tax more progressive.
- Learn more about UB’s M.S. in Taxation or M.S. in Accounting and Business Advisory Services programs.
Phillip Korb is an associate professor of accounting and the chair of the Department of Accounting, Finance and Economics in the Merrick School of Business. He is a licensed CPA and received his master’s degree in taxation from the University of Baltimore. He is also a former education member of the State of Maryland Board of Public Accountancy. Mr. Korb can be reached at firstname.lastname@example.org.
Kathryn Demarest is a lecturer in accounting in the Merrick School of Business. She is a licensed CPA and has earned both an MBA and Masters of Taxation from the University of Baltimore. She has more than 20 years of experience in the field of taxation, and represents low income clients in tax controversy cases through the Maryland Volunteer Lawyers Service. Ms. Demarest can be reached at email@example.com.