Are lump-sum payments from a nonqualified deferred compensation plan to nonresident former employees taxable by New York, and does the employer have to withhold tax on them?

Plain-English summary

The Limited Stores, Inc. maintained a nonqualified deferred compensation plan - The Limited Supplemental Retirement Plan ("the Nonqualified Plan") - that paid retirement benefits above the limits allowed under a companion qualified plan. All post-termination payments from the Nonqualified Plan were made as lump sums, at least 30 days after an employee's termination, and the plan was unfunded: participants were treated as mere general creditors of the employer, with no dedicated reserve of assets set aside for them. The Limited asked the Department three questions: whether these lump sums are exempt from New York state and New York City tax when paid to nonresident, nondomiciled former employees; whether withholding is required on payments to employees of out-of-state affiliates; and what withholding rules apply to employees of affiliates that do have a New York office, including whether the employer can rely on employee residency affidavits.

The Department held that the Nonqualified Plan qualifies as a "nonqualified deferred compensation plan" under IRC § 3121(v)(2)(C), and that its lump-sum, post-termination payments meet the definition of "retirement income" in 4 U.S.C. § 114(b)(1)(I)(ii) (income maintained solely to provide retirement benefits in excess of federal contribution/benefit limits). Under the federal preemption in 4 U.S.C. § 114(a), added by Public Law 104-95 for amounts received after December 31, 1995, no state may tax the retirement income of someone who is not a resident or domiciliary of that state. So lump sums paid to former employees who are nonresidents and nondomiciliaries of New York are exempt from New York State personal income tax (State PIT). The separate New York City nonresident earnings tax (City NET) question was declared moot because that tax had already been repealed effective July 1, 1999.

On withholding, the Department applied Tax Law § 671(a), which only obligates an employer "maintaining an office or transacting business" in New York to withhold. Affiliates of The Limited without a New York office or business presence need not withhold State or City personal income tax on Nonqualified Plan distributions to their employees. For affiliates that do have a New York office, no withholding is required for distributions to nonresident employees (because the underlying income isn't taxable to them at all), but withholding of State PIT and City PIT is required for distributions to employees who are New York State or City residents, since the federal preemption only protects nonresidents/nondomiciliaries. Finally, the employer may rely on Form IT-2104.1 (New York State Certificate of Nonresidence and Allocation of Withholding Tax) and Form IT-2104.2 (City of New York Certificate of Nonresidence) submitted by employees to determine residency status for withholding purposes.

What this means for you

Employers with nonqualified deferred compensation plans

If your unfunded, nonqualified plan pays lump sums to terminated employees solely to provide retirement benefits above federal qualified-plan limits, those payments can qualify as "retirement income" protected by 4 U.S.C. § 114(a). That means no New York withholding is owed on lump sums paid to nonresident, nondomiciliary former employees - regardless of whether your affiliate has a New York office - because the underlying payment isn't New York-taxable to them in the first place.

Payroll and withholding administrators

Withholding obligations under Tax Law § 671(a) only attach where the paying affiliate maintains an office or transacts business in New York. Even then, withhold only for employees who are New York State or City residents; nonresidents remain exempt. You can rely on a completed Form IT-2104.1 (state) or Form IT-2104.2 (city) from the employee to determine residency status rather than independently verifying it.

Accountants and tax professionals advising multi-state employers

Note that the City NET question in this opinion is now moot everywhere - Article 2-E of the General City Law was repealed effective July 1, 1999, so it no longer applies to any distribution regardless of these facts. Focus withholding analysis on State PIT and City PIT residency status instead.

Common questions

Q: Are lump-sum payments from a nonqualified deferred compensation plan automatically exempt from New York tax for nonresidents?
A: Only if the plan and payment meet the federal "retirement income" definition in 4 U.S.C. § 114(b)(1) - here, a plan under IRC § 3121(v)(2)(C) providing benefits above federal limits, paid after termination. If those conditions are met, the exemption in 4 U.S.C. § 114(a) applies to nonresidents and nondomiciliaries.

Q: Does the employer have to withhold on these payments to employees of an out-of-state affiliate?
A: No. Under Tax Law § 671(a), withholding is only required of an employer maintaining an office or transacting business in New York. Affiliates without a New York office or business presence have no withholding obligation on these distributions.

Q: What about employees of an affiliate that does have a New York office?
A: No withholding is required for that affiliate's nonresident employees, because the distributions aren't taxable to them under the federal exemption. Withholding of State PIT and City PIT is required, however, for that affiliate's employees who are New York State or City residents.

Q: Can the employer just rely on an employee's statement about where they live?
A: Yes - the employer may rely on Form IT-2104.1 (New York State Certificate of Nonresidence and Allocation of Withholding Tax) and Form IT-2104.2 (City of New York Certificate of Nonresidence) to determine residency status for withholding purposes.

Q: What happened to the New York City nonresident earnings tax (City NET) question?
A: It's moot. Article 2-E of the General City Law, which authorized the City NET, was repealed effective July 1, 1999, so the tax no longer applies to these distributions or any others.

Citations and references

• Tax Law § 671(a) - requires an employer maintaining an office or transacting business in New York to withhold personal income tax from taxable wages
• 4 U.S.C. § 114(a) (Public Law 104-95) - bars a state from taxing the retirement income of a nonresident or nondomiciliary, for amounts received after December 31, 1995
• 4 U.S.C. § 114(b)(1) - defines "retirement income," including post-termination payments from plans maintained solely to provide benefits above federal contribution/benefit limits
• IRC § 3121(v)(2)(C) - defines a "nonqualified deferred compensation plan"
• 20 NYCRR 171.3(a) (Personal Income Tax Regulations) - payments treated as wages for federal withholding are also wages for New York State withholding
• 20 NYCRR 171.6(b)(5) (Personal Income Tax Regulations) - nonresident withholding allocation and reliance on Certificate of Nonresidence (Form IT-2104.1)
• Article 2-E, General City Law - formerly authorized the City NET, repealed effective July 1, 1999 (L. 1999, Ch. 5; City of New York v State of New York, 94 NY2d 577)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2000.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a00_6i.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-00(6)I
Income Tax
September 6, 2000

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I991228B

On December 28, 1999, a Petition for Advisory Opinion was received from The Limited
Stores, Inc., Three Limited Parkway, Columbus, Ohio 43230.
The issues raised by Petitioner, The Limited Stores, Inc., are:

1. Whether the lump sum distributions from the Nonqualified Plan, described below,
   to distributees who have terminated their employment with the Limited, Inc. or its
   affiliates and who are nonresidents and nondomiciliaries of New York State and/or
   New York City are exempt from the personal income tax imposed pursuant to Article
   22 of the Tax Law (“State PIT”) and the New York City nonresident earnings tax
   imposed pursuant to Title 11, Chapter 19 of the New York City Administrative Code
   as authorized by Article 2-E of the General City Law (“City NET”).
2. Whether Petitioner is required to withhold State PIT or New York City personal
   income tax imposed pursuant to Title 11, Chapter 17 of the New York City
   Administrative Code as authorized by Article 30 of the Tax Law (“City PIT”) from
   distributions from the Nonqualified Plan, described below, that are made to
   employees of those affiliates of The Limited, Inc. that do not have an office or
   transact business in New York State.
3. Whether Petitioner, with regard to distributions made to employees of affiliates of
   The Limited, Inc. that have an office or transact business in New York State, (a) is
   required to withhold State PIT, City PIT or City NET from distributions from the
   Nonqualified Plan, described below, to employees who state that they are New York
   residents, and (b) is entitled to rely upon affidavits it receives from employees
   regarding their state of residence in determining whether it is required to withhold
   State PIT, City PIT or City NET from such distributions.
   Petitioner submits the following facts as the basis for this Advisory Opinion.
   Petitioner is a wholly-owned indirect subsidiary of The Limited, Inc. Effective August 1,
   1971, Petitioner adopted The Limited Stores, Inc. Savings and Retirement Plan, a qualified deferred
   compensation plan for certain employees of The Limited, Inc. and its affiliates. Various profit
   sharing plans of The Limited, Inc. were merged into this plan, effective as of January 1, 1992, and
   the plan was amended, restated and renamed The Limited, Inc. Savings and Retirement Plan (“the
   Qualified Plan”). A First Restatement of the Qualified Plan was adopted effective January 1, and
   April 2, 1992, in order to make certain changes in the design of the Plan. A Second Restatement of

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the Qualified Plan was adopted effective as of January 1, 1992, to make certain changes to the
Qualified Plan and to incorporate the amendments made to the Qualified Plan by the First
Restatement.
The Internal Revenue Service has issued a Determination Letter, dated January 30, 1995,
ruling that the Qualified Plan provides for retirement income that is income from a qualified trust
under section 401(a) of the Internal Revenue Code of 1986, as amended (“IRC”), that is exempt from
taxation under section 501(a) of the IRC.
Petitioner has also adopted a nonqualified deferred compensation plan for certain of its
employees, The Limited Stores Supplemental Retirement Plan, which was amended and restated
effective January 1, 1989. Effective January 1, 1992, The Limited Stores Supplemental Retirement
Plan was succeeded by The Limited Supplemental Retirement Plan (the “Nonqualified Plan”).
The Nonqualified Plan supplements and incorporates various definitions and provisions of
the Qualified Plan. The Nonqualified Plan provides deferred compensation that is retirement income
in excess of the limits imposed by sections 401(a)(17) and 417 of the IRC. Petitioner states that the
Nonqualified Plan is a plan described under section 3121(v)(2)(C) of the IRC.
All post-termination distributions from the Nonqualified Plan are to be made to participants
whose employment by The Limited, Inc., or its affiliates has been terminated for not less than 30
days. All distributions from the Nonqualified Plan are made in lump sum payments. Section 3.4 of
the Nonqualified Plan states that “[t]he Employer [Limited Service Corporation and its affiliates that
are participating employers under The Limited, Inc. Savings and Retirement Plan] will not, establish
any reserve of assets to provide funds for payments under the [Nonqualified] Plan. The interests of
Participants and Beneficiaries under the [Nonqualified] Plan will be solely those of general creditors
of the Employer.”
Discussion
Issue 1
Section 114(a) of Title 4 of the US Code, as added by Public Law 104-95, January 10, 1996,
and applicable to amounts received after December 31, 1995, provides that “[n]o State may impose
an income tax on any retirement income of an individual who is not a resident or domiciliary of such
State (as determined under the laws of such State).” Section 114(b)(1) of Title 4 of the US Code
defines the term “retirement income” as any income from, among other things:
(I) any plan, program, or arrangement described in section 3121(v)(2)(C) of
[the IRC], if such income –
(i) is part of a series of substantially equal periodic payments ... or

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(ii) is a payment received after termination of employment under a plan,
program, or arrangement (to which such employment relates) maintained solely for
the purpose of providing retirement benefits for employees in excess of the
limitations imposed by 1 or more sections 401(a)(17), 401(k), 401(m), 402(g),
403(b), 408(k), or 415 of [the IRC] or any other limitation on contributions or
benefits in [the IRC] on plans to which any such sections apply.
Section 3121(v)(2)(C) of the IRC defines a “nonqualified deferred compensation plan” as
any plan or any arrangement for the deferral of compensation other than a plan described in section
3121(a)(5) of the IRC (generally, ERISA or “qualified plans”).
Pursuant to section 114 of Title 4 of the US Code, New York State may not impose State PIT
on the retirement income of a nonresident or nondomiciliary individual after December 31, 1995.
In this case, the Nonqualified Plan is a plan or arrangement as described in section 3121(v)(2)(C)
of the IRC, and the lump sum distributions from such plan meet the requirements of section
114(b)(1)(I)(ii) of Title 4 of the US Code. Therefore, for purposes of State PIT, the lump sum
distributions from the Nonqualified Plan received by nonresidents of New York State will be treated
as retirement income as defined in section 114(b) of Title 4 of the US Code.
Accordingly, the lump sum distributions from the Nonqualified Plan, to distributees who
have terminated their employment with The Limited, Inc. or its affiliates, and are nonresidents and
nondomiciliaries of New York State, are exempt from State PIT pursuant to section 114(a) of Title
4 of the US Code.
The City NET was administered by New York State. However, effective July 1, 1999,
Article 2-E of the General City Law was repealed (L. 1999, Ch. 5; City of New York v State of New
York, 94 NY2d 577). Accordingly, the City NET is repealed, and the question regarding the lump
sum distributions from the Nonqualified Plan to distributees who are nonresidents and
nondomiciliaries of New York City is moot.
Issue 2
Section 671(a) of the Tax Law provides that “every employer maintaining an office or
transacting business within this state and making payment of any wages taxable under this article
shall deduct and withhold from such wages for each payroll period a tax computed in such manner
as to result, so far as practicable, in withholding from the employee’s wages during each calendar
year an amount substantially equivalent to the tax reasonably estimated to be due under this article
resulting from the inclusion in the employee’s New York adjusted gross income or New York source
income of his wages received during such calendar year.” (Emphasis added.)
Accordingly, pursuant to section 671(a) of the Tax Law, Petitioner is not required to withhold
State PIT from distributions from the Nonqualified Plan that are made to employees of affiliates of

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The Limited, Inc. that do not have an office or transact business in New York. Likewise, the
withholding of City PIT is not required from such distributions to employees of affiliates of The
Limited, Inc. that do not have an office or transact business in New York City.
Issue 3
Section 671(a) of the Tax Law provides that “every employer maintaining an office or
transacting business within this state and making payment of any wages taxable under this article
shall deduct and withhold from such wages ....” (Emphasis added.)
Section 171.3(a) of the Personal Income Tax Regulations provides that payments which are
considered wages for federal income tax withholding purposes are also wages for purposes of
withholding New York State personal income tax.
Section 31.3401(a)-1(b) of the Treasury Regulations provides that, for federal income tax
purposes, in general, pensions and retirement pay are wages subject to withholding. However, no
withholding is required with respect to amounts paid to an employee upon retirement which are
taxable as annuities under the provisions of section 72 or 403 of the Internal Revenue Code. If a
nonqualified deferred compensation plan provides for an unfunded and unsecured promise to make
payments at some future point in time, payments from the plan are subject to federal income tax
withholding when they are received by the employee. (See, e.g. Rev Rul 82-176, 1982-2 CB 223;
Rev Rul 77-25, 1977-1 CB 301.)
Section 35.3405-1(Q&A– A-21) of the Treasury Regulations provides that:
A-21. Q. An employer maintains a nonqualified deferred compensation plan
such as a supplemental executive retirement (“top hat”) plan. Payments under the
plan are made in the form of a single sum payment at retirement. Amounts paid at
retirement are includible in income as compensation in the year received. Must the
payor withhold on these amounts according to the rules in section 3405?
A. No. Section 3405(d)(1)(B)(i) provides that a designated distribution on
which withholding is required does not include amounts that are wages without
regard to the rules of section 3405. Therefore, withholding on payments that are
includible in income as compensation are based on the rules for withholding on
wages contained in section 3402.
In this case, the Nonqualified Plan is a nonfunded plan, and it is assumed that the
distributions to the participants from such Nonqualified Plan are wages pursuant to sections
31.3401(a)-1(b) and 35.3405-1(Q&A–A-21) of the Treasury Regulations.

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Accordingly, pursuant to sections 671(a) of the Tax Law, Petitioner is not required to
withhold State PIT from distributions from the Nonqualified Plan that are made to employees of
affiliates of The Limited, Inc. that do have an office or transact business in New York where the
employees are nonresidents of New York State, because such distributions are not taxable under
State PIT. (See Issue 1 above.) Since the City NET is repealed, the question regarding the
withholding of City NET from such distributions that are made to employees who are nonresidents
of New York City is moot.
However, the provisions of section 114 of Title 4 of the US Code, which exempts the
retirement income of a nonresident or nondomiciliary individual after December 31, 1995 from State
PIT do not apply to a resident individual of New York State or New York City. Accordingly,
pursuant to section 671(a) of the Tax Law, withholding of State PIT is required by Petitioner from
distributions from the Nonqualified Plan that are made to employees of affiliates of The Limited, Inc.
that have an office or transact business in New York State, where the employees are residents of
New York State. Likewise, withholding of City PIT from distributions from the Nonqualified Plan
that are made to employees who are residents of New York City is required by Petitioner for
purposes of the City PIT.
Pursuant to section 171.6(b)(5) of the State PIT regulations, an employer must withhold State
PIT from all wages paid to an employee who is a nonresident of New York State that performs
services partly within and partly without New York State, unless there is filed with the employer a
Certificate of Nonresidence and Allocation of Withholding Tax on Form IT-2104.1, or unless the
employer maintains adequate current records to accurately determine the amount of wages from New
York State sources. Petitioner may rely on a Form IT-2104.1 - New York State Certificate of
Nonresidence and Allocation of Withholding Tax and a Form IT-2104.2 - City of New York
Certificate of Nonresidence , respectively, that it receives from an employee of an affiliate of The
Limited, Inc. to determine that an employee is not a resident of New York State or New York City,
respectively, in determining whether it is required to withhold State PIT and City PIT, respectively,
from the distributions from the Nonqualified Plan that are made to such employee.

DATED: September 6, 2000

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.