Do withdrawals from a federal Thrift Savings Plan (TSP) count as 'retirement benefits from sources other than privately funded sources' for the Missouri income tax subtraction under Section 143.124.5, RSMo?

Subject

Withdrawals from a Thrift Savings Plan may be Retirement Benefits from other than Privately Funded Sources

Plain-English summary

The Missouri Department of Revenue ruled that withdrawals a retired federal employee takes in retirement from a Thrift Savings Plan (TSP) generally count as "retirement benefits received from sources other than privately funded sources" for purposes of the Section 143.124.5, RSMo income tax subtraction -- but with one important carve-out.

Applicant is a retired USPS employee under the Federal Employees Retirement System (FERS), receiving both an Office of Personnel Management pension and a TSP, which is a defined-contribution plan funded by both employee contributions and agency (USPS) matching contributions. Two years before the ruling, about $250,000 was transferred from the TSP into an IRA account, and in May 2022, about $68,000 was transferred back from that same IRA into the original TSP account.

Because the TSP is a "governmental plan" under IRC Section 414(d) -- established and maintained by the federal government, which is also the payer of benefits -- the Department concluded that TSP withdrawals are not from privately funded sources, even though the plan includes employee contributions. Those employee contributions were themselves deducted from compensation paid by a government employer, reinforcing the plan's governmental character.

However, an IRA is a private source of funding: it is "a trust created or organized...for the exclusive benefit of an individual or his beneficiaries" under IRC Section 408(a). When Applicant transferred funds from the TSP into an IRA and then rolled a portion of those same funds back into the TSP, the funds did not lose their private-source character. So the portion of a future TSP withdrawal attributable to the $68,000 rolled back in from the IRA is treated as a retirement benefit "from any privately funded sources" under Section 143.124.3, RSMo, rather than under Section 143.124.5.

What this means for you

Retired federal employees with a Thrift Savings Plan

If you are a retired federal employee drawing on a TSP, this ruling indicates your TSP withdrawals should generally qualify as retirement benefits "from sources other than privately funded sources" for the Section 143.124.5, RSMo subtraction -- subject to the income thresholds and phase-out described in that statute. This is true even though your own contributions helped fund the account, because the federal government established and maintains the plan and is the one paying out the benefits.

Taxpayers who have rolled IRA funds into a TSP

If you ever transferred money out of your TSP into an IRA, and later rolled some or all of it back into the TSP, this ruling means you cannot treat the entire eventual TSP withdrawal as coming from a non-privately-funded source. The portion traceable to the IRA rollover keeps its private-source character, so it falls instead under the privately-funded-source rules in Section 143.124.3, RSMo, which has its own separate subtraction calculation.

Accountants and tax professionals

When a client's retirement income includes TSP or similar governmental-plan withdrawals, ask specifically whether the client ever moved funds between the plan and a private IRA. As this ruling shows, commingled funds don't average out -- the Department traces the portion attributable to the IRA transfer and treats it differently for purposes of the Section 143.124.3 versus Section 143.124.5 subtractions, which have different maximum-subtraction and income-threshold rules.

Common questions

Q: Are TSP withdrawals treated as retirement benefits from a privately funded source or from a source other than privately funded sources?
A: Generally from a source other than privately funded sources, for purposes of Section 143.124.5, RSMo, because the TSP is a "governmental plan" under IRC Section 414(d) that is established, maintained, and paid out by the federal government.

Q: Does it matter that the taxpayer contributed some of their own money to the TSP?
A: No. Even though the TSP is funded in part by employee contributions, those contributions were deducted from compensation paid by the taxpayer's government employer, so the plan as a whole still counts as a source other than privately funded sources.

Q: What is the exception in this ruling?
A: The portion of a TSP withdrawal attributable to funds that were transferred from an IRA into the TSP is treated as coming from a privately funded source instead, because an IRA is a private trust under IRC Section 408(a) and the funds don't lose that private character when rolled into the TSP.

Q: Why does the source of the funds matter for Missouri income tax?
A: Section 143.124, RSMo allows a subtraction from Missouri adjusted gross income for certain retirement benefits, but the rules differ depending on whether the benefit is "from any privately funded sources" (subsection 3) or "from sources other than privately funded sources" (subsection 5) -- each with its own eligibility thresholds and maximum subtraction amounts.

Q: Can other taxpayers with a TSP rely on this specific ruling?
A: Not automatically. This is a Missouri letter ruling binding on the Department only with respect to the requesting Applicant, only for three years from its date, and only so long as the facts and underlying law remain unchanged. Other taxpayers should confirm their own facts match and consult a tax professional.

Source

• Landing page: Missouri DOR Rulings Search
• Ruling: LR 8197

Original ruling text

Dear Applicant,

This is a letter ruling issued by the Director of Revenue under Section 536.021.10, RSMo, and Missouri Code of State Regulations 12 CSR 10-1.020 in response to your request received April 26, 2022.

The facts as presented in your letter ruling request and from subsequent communication are summarized as follows:

Taxpayer is a retired Federal government employee who worked for the USPS. Under the Federal Employees Retirement System (FERS), they receive a pension from the Office of Personnel Management. In addition, taxpayer has a component of their retirement under FERS as a defined-contribution plan, known as the Thrift Savings Plan (TSP). This plan is overseen by the United States Congress and funded by both employee contributions as well as agency matching employer contributions (the USPS). Two years ago, approximately $250,000 was transferred from the TSP into an IRA account. Additionally, in May of 2022, approximately $68,000 was transferred from this same IRA account into the original TSP account.

ISSUE:

Are withdrawals made in retirement from the TSP counted as "retirement benefits received from sources other than privately funded sources" for purposes of section 143.124.5, RSMo?

RESPONSE:

Withdrawals made in retirement from the TSP are "retirement benefits received from sources other than privately funded sources" for purposes of section 143.124.5, except for the portion of those withdrawals attributable to the funds transferred from the IRA.

Section 143.124, RSMo, prescribes when certain retirement benefits or allowances may be subtracted from an individual income taxpayer's Missouri adjusted gross income. This statute identifies retirement benefits or allowances as either "from any privately funded sources" or "from sources other than privately funded sources."  Subsection 3 of Section 143.124 describes the circumstances under which a taxpayer may subtract "any retirement allowance received from any privately funded sources," for tax years beginning on or after January 1, 2002, and subsection 5 describes the circumstances under which "retirement benefits received from sources other than privately funded sources" may be subtracted for tax years beginning on or after January 1, 2007.

Generally, the retirement benefits allowed to be subtracted under Section 143.124, RSMo, must have been included in the taxpayer's federal adjusted gross income and not otherwise deducted in calculating Missouri taxable income. For retirement benefits from "sources other than privately funded sources[,]" the maximum possible subtraction is equal to a figure called the "maximum Social Security benefit available", which began at $32,500 for tax year 2007 and has been increased for inflation. To be eligible for this maximum subtraction, a taxpayer must have Missouri adjusted gross income equal to or less than the threshold of $85,000 (if filing as single, head of household, qualifying widow(er), or married filing separately) or $100,000 (if married filing combined). For each dollar by which the taxpayer's Missouri adjusted gross income exceeds the applicable threshold, the maximum subtraction allowed to that taxpayer is reduced by a dollar.

The TSP is administered through an entity created by federal law and is a "governmental plan."  IRC Section 414(d) defines this term and reads, in part, as follows:

For purposes of this part, the term "governmental plan" means a plan established and maintained for its employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing.

Although this plan is funded, in part, by employee contributions, the federal government established and maintains the plan and is the payer of the benefits. Moreover, the taxpayer's employee contributions were deducted from compensation paid to the taxpayer by the taxpayer's government employer. Except for the portion of the withdrawals attributable to funds transferred from the IRA, benefits paid by this plan are not from privately funded sources, but are from sources other than privately funded sources, for the purposes of Section 143.124.5.

By contrast, an IRA is "a trust created or organized [...] for the exclusive benefit of an individual or his beneficiaries" and the trustee generally must be a bank. IRC Section 408(a). An IRA is a private source of funding for retirement and, when funds are transferred or rolled over from an IRA into a TSP, the funds do not lose their character as a private source of retirement benefits. Accordingly, the portion of a withdrawal in retirement from a TSP is a retirement benefit "from any privately funded sources" to the extent the amount withdrawn is attributable to funds from the IRA.

This letter ruling is binding upon the Department of Revenue with respect to the Applicant for three (3) years from the date of this letter and is subject only to statutory changes by the General Assembly and to changes in the interpretation of law by the courts or administrative tribunals. If a change occurs, the taxpayer who relies upon an outdated interpretation may be subject to additional taxes, interest and penalties, which may be imposed prospectively from the date of the change. For this reason, the interpretation set forth above should be reviewed on a regular basis. Please note that any change in or deviation from the facts as presented will render this ruling inapplicable.

Should additional information be needed, please contact Legal Counsel Caleb J. Wiedner, General Counsel's Office, Post Office Box 475, Jefferson City, Missouri, 65105-0475, phone (573) 751-0961.

Sincerely,

Wayne Wallingford