Education

Thank you for your help.  I believe you're misreading the MI instructions, even if (I think) we get to the same conclusion.  So that no one else who might read this conversation later gets confused, I'll explain why I think this is so.

 

The instructions for MI Schedule 1, Line 8 read:  "Add, to the extent not included in AGI, the amount of money [emphasis added] withdrawn in the tax year from a Michigan Education Savings Plan (MESP) account, including the Michigan 529 Advisor Plan (MAP), or a Michigan Achieving a Better Life Experience Program (MiABLE) account, if the withdrawal was not a qualified withdrawal as provided in the MESP or ABLE Acts.  You may first exclude any amount that represents a return of contributions for which no deduction was claimed in any prior tax year."

 

Michigan does not instruct you to add back "earnings", it instructs you to add back "money".   Both earnings and basis count as "money".  As you point out, because AGI is the starting point for the MI return, any earnings attributable to non-qualified withdrawals should already be in the MI tax base.  If, for whatever reason, some are not, the wording in the instructions makes clear that they must be added.  Further, any basis attributable to non-qualified withdrawals must be added back to the MI tax base since the contributions were (presumably) deducted from the MI return in the year in which they were made.  If, for some reason, the deduction wasn't taken for part/all of the basis attributable to the non-qualified withdrawal (eg, the taxpayer chose not to take the deduction, forgot to do so, or contributed more than $10,000 in a given tax year, which is the maximum annual deduction), the second sentence of the instructions allows the taxpayer to exclude that amount of the basis from the add-back (because it's already been taxed).

 

An example:   Let's say I withdrew $300 from my son's MESP in 2024, and that 60% of that amount was earnings and 40% was basis.  And let's say that I only had $200 of qualified expenses.  Therefore, $100 was an excess distribution:  $60 from earnings and $40 from basis.

 

On the federal return I'm taxed on the $60 attributable to earnings in 2024.  The IRS doesn't care about the basis because they never gave me a deduction for it in the first place (ie, when I contributed it, which was probably in a prior tax year).  This $60 automatically flows through to my MI return because it's baked into AGI, the starting point for MI taxable income.  But the $40 (ie, the basis attributable to non-qualified expenses) also needs to end up in my MI tax base.  That's what goes into Line 8 of Schedule 1 (unless, for some reason, I didn't take the deduction on some or all of that basis in the first place).

 

I think we're in agreement on all that, even if we describe it slightly differently - let me know if you think I've got something wrong.  And even if we are in agreement, apparently the TurboTax programming team needs to get the memo as well.  In the meantime, I'll have to make the adjustment manually to my return to ensure that it's compliant with the law.