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A Better Partnership
February 22, 2013

COA Opinion: Distributions from a private IRA are tax-free when the principal originated from a tax-exempt 403(b) retirement account

The plaintiff's now-deceased husband had contributed to a state tax-exempt 403(b) retirement account during his employment at Michigan State University. After his retirement, he transferred the money from the 403(b) account to a private Individual Retirement Account. All of the money in the IRA originated from the 403(b) account. When the plaintiffs received distributions from the IRA, they deducted the amount from their adjusted gross income on their state income tax return. The Treasury Department objected, claiming the amount was subject to state income tax. The Michigan Court of Appeals explained in Magen v. Department of Treasury that the determination of whether the distributions from the IRA were subject to state taxation required analysis and harmonization of two provisions of the tax code. Under the first provision, distributions from a 403(b) account are tax-free; the second provision requires taxation of distributions from private IRAs. The parties did not dispute that if the plaintiffs had placed the money from the 403(b) account in a bank account or ordinary investment account, the interest would be taxable, but the principal would remain tax-free. Accordingly, the Court of Appeals concluded that the principal balance, when placed in an IRA, remained tax-free. The court affirmed the trial court's grant of summary disposition to the plaintiff. Judge Wilder dissented, claiming that the plain language of the statute required taxation of distributions from a private IRA.

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