How Does the Maryland Retirement Tax Elimination Act Work?

The Maryland Retirement Tax Elimination Act of 2022 introduced changes to how retirement income is taxed in the state. The legislation’s name can be misleading, as it does not completely eliminate all state taxes for every retiree. Instead, the act expanded a long-standing tax benefit known as the pension exclusion, which allows eligible taxpayers to subtract a portion of their retirement income from their state tax calculation.

This law aims to provide financial relief to seniors by increasing the amount of retirement income that can be shielded from Maryland’s income tax. While the act also created a separate, nonrefundable tax credit for certain seniors, the core of the legislation revolves around enhancing this income subtraction. The benefit is not automatic and requires taxpayers to meet specific criteria and follow a defined process on their tax returns.

Eligibility Requirements for the Tax Relief

To qualify for Maryland’s expanded pension exclusion, a taxpayer must meet specific conditions related to age or disability status. The primary requirement is that the individual must be 65 or older by the last day of the tax year, or be considered totally and permanently disabled. This disability status can apply to the taxpayer or their spouse.

The source of the retirement income is a determining factor for eligibility. The income must originate from an employee retirement system, which includes qualified pension plans, annuities, or endowments. Qualifying income sources include distributions from:

• 401(a) plans
• 401(k) plans
• 403(b) plans
• 457(b) plans

This includes most employer-sponsored retirement plans from private companies, non-profits, and government agencies.

Income from certain retirement accounts does not qualify for this subtraction. Ineligible income sources include distributions from:

• Traditional and Roth IRAs
• Rollover IRAs
• Simplified Employee Pension (SEP) plans
• Keogh plans

Unlike some other state tax benefits, there is no specific income limit to qualify for the pension exclusion itself.

Calculating the Retirement Income Subtraction

The benefit of the pension exclusion is realized as a subtraction modification, which directly reduces a taxpayer’s Maryland adjusted gross income. This is not a tax credit, but rather a reduction of the total income that is subject to state tax. The calculation begins with a maximum exclusion amount set by the state, which is indexed for inflation annually. For the 2024 tax year, this amount is $39,500.

This maximum amount is then reduced by any Social Security or Railroad Retirement benefits the taxpayer received during the year. This step is required regardless of whether those federal benefits were taxable on the federal return. If a taxpayer’s total Social Security and Railroad Retirement benefits exceed the maximum exclusion amount, their allowable pension exclusion for that year is reduced to zero.

For example, if a qualifying individual received $20,000 in Social Security benefits, their potential exclusion would be reduced from $39,500 to $19,500. The final subtraction amount is the lesser of this adjusted figure or the actual amount of qualifying pension income received. If that same individual received $15,000 from a qualifying 401(k) plan, their subtraction would be limited to the $15,000 they actually received, since it is less than the calculated potential exclusion of $19,500.

This calculation must be performed for each spouse separately if filing a joint return where both individuals receive qualifying retirement income. Each spouse calculates their own exclusion based on their own pension income and their own Social Security benefits. The final amounts are then combined and entered as a single subtraction on the joint tax return.

How to Claim the Subtraction on a Tax Return

To claim the pension exclusion, taxpayers must complete specific calculations and forms when filing their Maryland Resident Income Tax Return, Form 502. Taxpayers must use the Pension Exclusion Computation Worksheet, which is designated as Worksheet 13A within the official Maryland Form 502 instruction booklet.

The process begins with the worksheet, where the taxpayer enters their total qualifying pension income for the year. The taxpayer must also enter the maximum allowable exclusion amount for the tax year and the total Social Security and Railroad Retirement benefits they received. Subtracting the Social Security benefits from the maximum exclusion determines the potential exclusion.

The final allowable subtraction is the smaller of the qualifying pension income or the potential exclusion calculated on the worksheet. This final figure is then transferred to the appropriate line on Form 502, and the taxpayer must check the box to indicate they are claiming the exclusion.

In addition to completing the worksheet and Form 502, taxpayers claiming the pension exclusion must also complete and attach Form 502R, the Maryland Retirement Income Information form. Failure to attach the required Form 502R can result in delays or denial of the subtraction.