USA Mandatory(?) Michigan State Income Tax Withholding by IRA Custodian


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I reside in Michigan and have a Traditional IRA account held by a custodian located in Maryland. It's that large publicly traded global asset management firm headquartered in Baltimore. This company has no operations in the state of Michigan and does not appear to be subject to Michigan taxes or jurisdiction. I did a Roth conversion of part of the account last year amounting to $11,000 and chose to have no taxes withheld. The $11,000 would not be subject to Michigan income tax in my situation, and I will pay the federal income tax due on the $11,000 when filing my 1040. When my transaction was processed, the custodian deducted 4.25% (i.e. the Michigan individual income tax rate) from the $11,000 to remit to the Michigan Treasury Department. The remainder of the $11,000 was deposited in the new Roth conversion account. This surprised me because I had not encountered this with a few other Roth conversions I had done with other out-of-state custodians (including a 2017 Roth conversion). So I called the custodian and was told Michigan is one of a few mandatory withholding jurisdictions including Washington, D.C. and possibly Connecticut. I was also told that no tax would have been withheld if I had previously filed form "MI W-4P" with the custodian wherein I could have declined Michigan tax withholding. My position is that the custodian is wrong in saying the MI W-4P was required to avoid the tax withholding. The instructions for the form specifically state the following at the beginning of the second paragraph: "Entities subject to Michigan taxes that disburse pension or annuity payments are required to collect withholding if the payment is expected to be taxable unless you opt out using this form...Entities over which Michigan does not have jurisdiction are not required to withhold Michigan income tax..." This language seems to support my opinion that the custodian was wrong to withhold the tax. Even if the custodian is subject to Michigan tax or jurisdiction, then it should have asked me if I expected the payment to be taxable (instead of assuming it would be). I could have said "no" and still avoided the withholding without filing form MI W-4P according to the first sentence in the second paragraph of the instruction.

Any opinions on this? A copy of the MI W-4P is attached.
 

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