How did California tax the four-year income from a 1998 traditional-to-Roth IRA conversion when the taxpayer moved into or out of California?

Plain-English summary

Legal Ruling 1998-3 addressed taxpayers who converted a traditional IRA to a Roth IRA before January 1, 1999, spread the taxable conversion income over four years, and changed California residency during that period.

FTB's rule followed residency during each installment period:

• A taxpayer who moved into California included the ratable portions reportable after becoming a resident.

• A taxpayer who moved out of California excluded the ratable portions reportable after becoming a nonresident.

• If residency changed during one of the four years, the annual one-fourth installment was prorated by California-resident days under the ruling's specified fraction.

The historical four-year rule

For an eligible conversion from a traditional IRA to a Roth IRA before January 1, 1999, California required the taxable distribution to be included ratably over four taxable years beginning with the conversion year.

The ruling notes that, as of its issue date, federal law allowed a taxpayer to elect to include the full amount in the conversion year, but California had not conformed to that election.

Moving into California

An inbound taxpayer had to include the installments reportable after becoming a California resident.

Revenue and Taxation Code section 17041 taxed a resident's entire taxable income, including the annual conversion amount under section 17507.6. FTB concluded that the accrual protection in section 17554 did not block the tax.

Section 17554 addressed discriminatory results caused by cash-versus-accrual accounting after a residency change. Here, every taxpayer reported the conversion ratably over four years regardless of accounting method. Because the accounting-method condition was absent, FTB said the accrual provision did not apply.

Moving out of California

An outbound taxpayer included only the portions reportable before becoming a nonresident.

Revenue and Taxation Code section 17952.5 excluded qualified retirement income, including IRA income, received by a nonresident on or after January 1, 1996. Although the conversion income was recognized over four years, the ruling treated the distribution as received in 1998.

The installments recognized after the taxpayer became a nonresident therefore fell within the statutory exclusion.

Proration in the year of the move

Move during the 1998 conversion year

The California amount was:

One-fourth of the taxable distribution × California-resident days from the distribution date through year-end ÷ total days from the distribution date through year-end.

Move during the second, third, or fourth year

The California amount was:

One-fourth of the taxable distribution × California-resident days in the taxable year ÷ total days in that taxable year.

FTB described this time-based approach as its long-standing administrative practice for assigning fungible income and deductions across resident and nonresident periods.

What this means for you

Historical 1998 Roth-conversion research

Identify the original distribution date, the taxable conversion amount, the four reporting years, and the exact California residency dates. The first-year fraction differs from the fraction for years two through four.

Taxpayers who moved into California

Under this ruling, later installments became taxable when recognized during California residency even though the conversion occurred while the taxpayer was a nonresident.

Taxpayers who moved out of California

Later installments were excluded once the taxpayer became a nonresident because the ruling applied the qualified-retirement-income exclusion.

Current-year questions

Do not reuse the four-year method or the ruling's historical eligibility threshold for a modern conversion. Research the current conversion, residency, sourcing, and retirement-income rules.

Common questions

Q: Did an inbound taxpayer owe California tax on installments after moving in?

A: Yes. The ruling included the ratable portions reportable during California residency.

Q: Did an outbound taxpayer owe California tax on installments after moving out?

A: No under the ruling. Section 17952.5 excluded those post-move qualified-retirement-income amounts.

Q: Was the entire annual installment taxed in the year of a midyear move?

A: No. The one-fourth installment was prorated by California-resident days.

Q: Why was the first-year formula different?

A: Its denominator ran only from the distribution date through the end of the conversion year. Later-year denominators used every day in the taxable year.

Q: Did California permit the federal election to report all conversion income in 1998?

A: The ruling's footnote says California had not conformed to that federal provision as of the notice date.

Citations and references

• Cal. Rev. & Tax. Code §§ 17041, 17507.6, 17554, and 17952.5
• I.R.C. § 408A
• Taxpayer Relief Act of 1997, Pub. L. No. 105-34
• Appeal of Virgil M. and Jeanne P. Money (Cal. State Bd. of Equalization, Dec. 13, 1983)

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 1998-3

Original ruling text

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Legal ruling 1998-3

STATE OF CALIFORNIA
Franchise Tax Board - Legal Division
PO Box 1720
Rancho Cordova CA 95741-1720

916 845 3309

FAX: 916 845 3648

Kathleen Connell, Chair
Dean Andal, Member
Craig L. Brown, Member

October 6, 1998

Taxation of IRA Distributions Rolled Over to a Roth IRA Followed by a Change of Residence Status

Issue

What portion of a distribution from a regular individual retirement account (IRA) rolled over to a Roth IRA during 1998 is subject to California tax upon a change of residence status?

Law

Revenue and Taxation Code (Rev. and Tax. Code) section 17507.6 added by Ch. 612, Laws 1997, applicable to taxable years beginning on or after January 1, 1998, generally conforms to the Roth IRA provisions of Internal Revenue Code (Int. Rev. Code) section 408A, added by P.L. 105-34 applicable to taxable years beginning after December 31, 1997.

Pursuant to Rev. and Tax. Code section 17507.6(c)(3)(B), an individual whose federal adjusted gross income does not exceed $100,000 and who does not file a separate return as a married individual may make a rollover contribution from a regular IRA to a Roth IRA. The rollover contribution is deemed to be a distribution from a regular IRA and included in gross income under the rules otherwise applicable to regular IRAs. (Rev. and Tax. Code section 17507.6(d)(3)(C).)

If an eligible individual makes a rollover contribution from a regular IRA to a Roth IRA before January 1, 1999, the amount required to be included in gross income must be included in income ratably over four taxable years beginning in the taxable year in which the distribution occurs.[1] (Rev. and Tax Code section 17507.6 (d)(3)(A)(iii).)

This notice addresses concerns that arise (1) when a nonresident individual makes a rollover contribution from a regular IRA to a Roth IRA before January 1, 1999, and during the following four-year period becomes a California resident (inbound taxpayer), and (2) when a resident of California makes a rollover contribution from a regular IRA to a Roth IRA before January 1, 1999, and during the following four year period becomes a nonresident (outbound taxpayer).

Analysis

Inbound Taxpayers

Inbound taxpayers must include in gross income the ratable portions of the taxable distribution reportable under the four-year rule after they become California residents.

Rev. and Tax. Code section 17041 imposes tax on the entire taxable income of every resident of this state. Taxable income is defined to include gross income from regular IRAs, which are rolled over to Roth IRAs (Rev. and Tax. Code section 17507.6) An individual who makes a rollover contribution from a regular IRA to a Roth IRA before January 1, 1999, is required to include one fourth of the taxable portion of the IRA distribution in gross income in each of four consecutive years beginning with the year of distribution. (Ibid.) Because residents are subject to tax on their entire taxable income, and because taxable income includes gross income from an IRA rollover in the situation described, an individual must include in gross income the ratable portions reportable under the four-year rule after he or she becomes a California resident.

Rev. and Tax. Code section 17554, the accrual provision, does not prevent California from assessing tax on the portions reportable after the individual becomes a resident. Section 17554 states, in general, that California may not impose tax on income from sources outside this state if the income accrued when the individual was a nonresident, even though the income is recognized after the taxpayer becomes a California resident. Section 17554 comes into play, however, if and only if, two conditions are satisfied:

California’s sole basis for imposing tax is residency, and

Taxation would differ depending on whether the taxpayer uses the cash or accrual method of accounting. (Appeal of Virgil M. and Jeanne P. Money, Cal. St. Bd. of Equal., December 13, 1983.)

The purpose of section 17554 is to prevent discriminatory taxation following a change of residency based on whether the taxpayer uses the cash or accrual method of accounting. (Supra.)

In the situation where California is attempting to tax an individual who becomes a resident after making a rollover contribution from a regular IRA to a Roth IRA before January 1, 1999, the first condition is satisfied. The sole basis for imposing tax is that the individual has become a California resident during the four-year period the income is recognized. However, the second condition is not satisfied. All taxpayers, cash and accrual alike, must report the taxable distribution ratably over four years. Thus, there exists no possibility of discriminatory taxation following a change of residency based upon the use of different accounting methods. Accordingly, section 17554 is never applied. All taxpayers must include the ratable share of the taxable distribution in gross income after they become California residents.

Outbound Taxpayers

Outbound taxpayers must include in gross income only those portions of the taxable distribution reportable under the four-year rule before they become nonresidents.

As discussed above, Rev. and Tax. Code sections 17041 and 17507.6 require residents of California to include in gross income the taxable portions of regular IRAs rolled over to Roth IRAs before January 1, 1999, over a four-year period.

Rev. and Tax. Code section 17952.5, however, prevents California from imposing tax on the portions of the IRA distribution recognized after the individual becomes a nonresident. Section 17952.5 states that gross income of a nonresident does not include qualified retirement income, including income from an IRA, received on or after January 1, 1996. In the case of a rollover from a regular IRA to a Roth IRA subject to the four-year rule, the distribution is deemed to have been received during 1998. Accordingly, any amount included in gross income under the four-year rule after the individual becomes a nonresident falls squarely within the exemption from gross income provided by section 17952.5.

Year One Proration

An individual who makes a rollover contribution from a regular IRA to a Roth IRA before

January 1, 1999, and thereafter during the same taxable year changes residency, must include in California adjusted gross income one fourth of the taxable portion of the distribution multiplied by a fraction, the denominator of which is the number of days from the date of the distribution until the end of the taxable year in which the distribution occurs and the numerator of which is the number of days in the denominator in which the individual is a resident of California.

If a taxpayer changes residency during the second, third, or fourth year, the amount included in California adjusted gross income for the year of the change in residency is one fourth of the taxable distribution multiplied by a fraction, the denominator of which is the total number of days in the taxable year and the numerator of which is the number of days in the year in which the individual is a California resident.

Long-standing administrative practice apportions fungible items of income and deductions to periods of residency based upon the amount of time an individual is a resident of California. Thus, the time approach is the required method for apportioning the taxable distribution required to be included in gross income under the four-year rule in the circumstance when a change of residency occurs during the four taxable year period following the distribution.

Drafting Information

The principal author of this notice is Richard Gould of the Franchise Tax Board, Legal Branch. For further information regarding this ruling, contact Mr. Gould at the Franchise Tax Board, Legal Branch, P.O. Box 1720, Rancho Cordova, CA 95741-1720.

Footnotes

As of the date of this notice, California has not conformed to provisions of P.L. 105-206 which allow a taxpayer to elect to include the taxable distribution in gross income in the year the distribution occurs.↵Return to reference

Last updated: 09/24/2025