Michigan workers who earn tips and overtime pay will not be able to claim new state tax deductions when they file returns this spring for 2025 income. The deductions will apply beginning with income earned in 2026, which means the first Michigan returns claiming them will be filed in early 2027.
The deductions were included in budget negotiations reached last September between Gov. Gretchen Whitmer and legislative leaders. Under the agreement, eligible workers will be allowed to exclude qualified tip income and qualified overtime pay from Michigan taxable income for tax years 2026, 2027, and 2028.
State officials have said the one-year delay is tied to payroll reporting requirements. Employers need time to update payroll and tax reporting systems so tips and overtime can be identified separately on state tax forms. The reporting changes are intended to align with similar federal filing requirements that begin in 2026.
Michigan’s income tax rate is 4.25%. The value of the deductions will depend on the amount of qualified tip income or overtime pay a worker earns and reports. Workers with higher amounts of eligible income would see larger reductions in taxable income under the temporary policy.
The change is expected to affect workers in sectors where overtime and tip income are common. Overtime-eligible employees are concentrated in industries including manufacturing, healthcare, hospitality, and retail. Tip income is most common in restaurants, bars, hotels, and some personal service jobs.
A parallel federal policy took effect earlier. Federal legislation passed in early 2025 created a deduction for qualified overtime pay beginning with 2025 tax returns, one year before Michigan’s state deduction begins. Under that federal provision, workers filing 2025 returns can report qualified overtime amounts even though separate employer reporting is not yet required.
Beginning with 2026 federal returns, employers will be required to separately identify overtime pay on W-2 and 1099 forms. Michigan’s timeline follows that same general reporting schedule, with state deductions beginning for the 2026 tax year after employers have had time to make payroll system changes.
Michigan businesses are expected to update payroll systems before the end of 2025 to comply with the new state reporting requirements. Employers will need to determine which workers have qualified overtime under federal wage and hour rules and ensure those amounts are tracked accurately for state tax reporting purposes. Tips will also need to be reported in a way that allows them to be identified for the deduction.
The policy does not change payroll tax withholding requirements for Social Security and Medicare taxes. Those federal taxes will continue to apply to wages, including tips and overtime pay, regardless of the state income tax deduction.
The Michigan deductions are scheduled to remain in effect for three tax years. Workers would claim them on returns filed in 2027, 2028, and 2029 for income earned in 2026, 2027, and 2028. Unless the Legislature extends the policy, the deductions will expire after tax year 2028.
The new deductions arrive alongside other tax changes affecting Michigan taxpayers. Federal changes enacted for 2025 also increased the cap on the state and local tax deduction for many filers, while Michigan continues to allow certain business entities to elect to pay tax at the entity level under the state’s pass-through entity tax system.
The Michigan policy was presented by state leaders as tax relief for workers who earn tips and overtime pay. Supporters said it was aimed at providing targeted relief to hourly and service-sector workers rather than changing the state’s overall income tax rate.
Workers will not see the state deduction on 2025 returns filed this year. Instead, the first tax year covered by the Michigan deductions will be 2026, with the first claims appearing on state returns filed in early 2027.
Source: Confused by Michigan taxes? Tip, overtime and senior rules explained | Detroit Free Press