| Tax-free
Pension Rollovers into IRAs
By
Mark H. Levin
The
New York State Tax Law, section 612(c)(3)(i), provides,
“[T]here shall be subtracted from federal adjusted
gross income: Pensions to officers and employees of this
state, its subdivisions and agencies, to the extent excludable
in gross income for federal income tax purposes.”
Tax Law section 612(c)(3-a) provides that the first $20,000
per year of any pensions or annuity income [which are not
otherwise tax-exempt under Tax Law section 612(c)] received
by individuals over the age of 59 Qs at the time of the
receipt of the distribution are also exempt from income
taxation.
Based
on this provision, all pensions received by officers and
employees of New York State, its subdivisions, and its agencies,
are exempt from state income taxation. It is less clear
whether the tax-exempt attribute of the governmental pension
remains intact after it is rolled over, in a tax-free transaction,
into an individual retirement account (IRA).
In
two recent Advisory Opinions, Larry J. Green [Adv
Op Comm T&F, TSB-A-03(4)I, November 19, 2003] and Richard
Epstein [Adv Op Comm T&F, TSB-A-03(5)I, November
19, 2003], the New York State Department of Taxation and
Finance has stated that when a tax-exempt governmental pension
is rolled over in a tax-free transaction into an IRA, any
distributions from the rollover IRA will be tax exempt to
the extent that they are attributable to the tax-exempt
amount rolled over into the IRA. Any subsequent income or
growth of the initial tax-exempt amount rolled into the
IRA is taxable to the extent provided in Tax Law section
612(c)(3-a). The opinions also set forth the method for
calculating taxable and nontaxable portions of any distributions
from the rollover IRA.
In
applying the opinions, it is clear that the rollover IRA
is partially tax exempt, raising the question as to how
to compute the tax-exempt amounts under Tax Law sections
612(c)(3)(i) and 612(c)(3-a).
In
reaching its opinions, the department looked back 23 years
to an old advisory opinion, Joseph W. Martiney
[Adv Op St Tax Comm, November 24, 1980, TSB-H-80-(523)I].
In Martiney, “the distributions from an IRA
established by means of a tax-free rollover of amounts received
in the form of a distribution from New York State or a subdivision
or agency thereof, represents a nontaxable return of principal
to the extent that the distribution is a return of pension
funds rolled over” into the IRA. To the extent that
the distribution represents interest, or any other type
of income or gain earned in the account, such portion would
be subject to tax.
In
the opinions, the department sets forth the method for computing
the nontaxable portion of any amount distributed from an
IRA whose principal consists of tax-exempt monies: “in
a partial distribution of an IRA established by means of
a tax-free rollover, to determine the amount that represents
a return of nontaxable funds, the amount of contributions
rolled over … to the IRA should be divided by the
total value of the IRA, including the amount of the distribution,
… and the result should be multiplied by the amount
distributed. This computation is used for the initial year
that a distribution is made and each succeeding year until
the amount of nontaxable contributions is recovered.”
New York’s formula is based upon that found in IRS
Notice 87-16, 1987-1 CB 446. Any distribution in excess
of the nontaxable amount so computed is taxable pursuant
to the provisions of Tax Law section 612(c)(3-a).
A taxpayer
receiving a distribution from an IRA that has been funded
through contributions of tax-exempt monies can exclude from
income an amount computed using the above formula. Any taxable
balance may then be added to any other pension or annuity
income, if any, that qualifies under Tax Law section 612(c)(3-a)
and Regulations section 112.3(c)(2). The first $20,000 will
be excluded; any remainder will be subject to income taxation
by New York State.
Mark
H. Levin, CPA, is manager, state and local taxes,
at H.J. Behrman & Company, LLP. |