Are lump-sum distributions from a nonqualified deferred compensation plan to terminated nonresident employees exempt from New York personal income tax, and when must the paying company withhold tax on such distributions?

Plain-English summary

Limited Service Corporation, a wholly-owned indirect subsidiary of The Limited, Inc., adopted a nonqualified deferred compensation plan effective January 1, 2000 - the Limited Supplemental Retirement and Deferred Compensation Plan (the "Nonqualified Plan") - for certain employees of The Limited's affiliates. The Nonqualified Plan combined two earlier plans that had provided benefits above the limits the Internal Revenue Code imposes on qualified retirement plans (IRC §§ 401(a)(17), 415, 401(k) and 401(m)). Under the plan, all distributions to a participant are paid as a single lump sum as soon as practicable - but no earlier than 30 days - after the participant's termination of employment, and a participant's right to a distribution is only an unsecured claim against the general assets of The Limited, Inc. or its affiliates.

Petitioner asked three things: (1) whether lump-sum distributions to terminated employees who are nonresidents and nondomiciliaries of New York are exempt from New York personal income tax; (2) whether Petitioner must withhold New York State or New York City tax from distributions made to employees of affiliates that have no office and do not transact business in New York; and (3) for affiliates that do have a New York office or transact business here, whether Petitioner must withhold from distributions to employees who say they are New York residents, may rely on employee affidavits about residence, and would face a penalty if a relied-upon affidavit later proved false.

The Department held that the Nonqualified Plan is a plan described in IRC § 3121(v)(2)(C), and that its lump-sum distributions meet the definition of "retirement income" in 4 U.S.C. § 114(b)(1)(I)(ii). Because federal Public Law 104-95 bars states from taxing the retirement income of nonresidents and nondomiciliaries, those lump-sum distributions are exempt from New York personal income tax for terminated employees who are nonresidents and nondomiciliaries of New York. This tracked an earlier advisory opinion the Department had issued to an affiliated petitioner, The Limited Stores, Inc. (TSB-A-00(6)I), regarding a predecessor plan.

On withholding, the Department applied the plain text of Tax Law § 671(a) and the parallel New York City Administrative Code § 11-1771: withholding is required only from an employer "maintaining an office or transacting business" in New York (or New York City). So Petitioner need not withhold from distributions paid through affiliates with no New York office or business. Where an affiliate does have a New York office or transacts business here, Petitioner still need not withhold for nonresident employees (because their distributions aren't taxable at all, per Issue 1), but must withhold for employees who are New York State or City residents. Petitioner may rely on Forms IT-2104.1 and IT-2104.2 that employees submit to establish nonresidence, and will not be penalized for relying on a false form as long as Petitioner has no actual knowledge it is false - though the employee who submitted a baseless false statement could face the penalty under Tax Law § 685(s).

What this means for you

Companies paying nonqualified deferred compensation to a mobile workforce

If your nonqualified plan is structured as an unfunded, unsecured arrangement described in IRC § 3121(v)(2)(C) that pays benefits in excess of qualified-plan limits, lump-sum payments to terminated employees who are nonresidents and nondomiciliaries of New York at the time of payment should be exempt from New York personal income tax under federal Public Law 104-95 (4 U.S.C. § 114). That exemption travels with the employee's residency status, not with where the paying entity is based.

Employers with a mix of New York and out-of-state affiliates

Your withholding obligation turns on whether the specific affiliate employing the recipient maintains an office or transacts business in New York, not on whether the parent company or plan sponsor does. No New York office or business activity by the affiliate means no withholding duty at all for that affiliate's distributions. If the affiliate does have a New York presence, withhold only for employees who are actual New York State or City residents, and you can lean on properly completed nonresidence certificates (Form IT-2104.1 / IT-2104.2) to make that call, provided you don't know them to be false.

Common questions

Q: Does this exemption apply to any nonqualified deferred compensation plan, or only this specific one?
A: The ruling is limited to the facts presented - a plan described in IRC § 3121(v)(2)(C) whose lump-sum distributions meet the "retirement income" definition in 4 U.S.C. § 114(b)(1)(I)(ii). A plan with different terms (for example, one not tied to exceeding qualified-plan limits) would need its own analysis.

Q: Do we have to withhold New York tax if our affiliate has no office and does no business in New York?
A: No. Under Tax Law § 671(a) and N.Y.C. Administrative Code § 11-1771, only an employer maintaining an office or transacting business in New York (or New York City) has a withholding obligation there.

Q: What if the affiliate does have a New York office, but the employee is a nonresident?
A: No withholding is required, because the distribution itself is exempt from New York personal income tax under 4 U.S.C. § 114(a) - there's simply no tax to withhold against.

Q: Can we rely on an employee's nonresidence certificate if it later turns out to be wrong?
A: Yes, per 20 NYCRR 171.6(b)(5), you may rely on Form IT-2104.1 (and Form IT-2104.2, though obsolete) and won't be penalized for relying on a false certificate as long as you have no actual knowledge it is false. The individual who submitted a groundless false statement, however, can be subject to the penalty in Tax Law § 685(s).

Q: Are these lump-sum payments treated as wages at all?
A: Yes - the opinion assumes the distributions are wages under Treasury Regulations §§ 31.3401(a)-1(b) and 35.3405-1 (Q&A-21), which is why the ordinary wage-withholding rules of Tax Law § 671(a) (rather than pension-distribution withholding rules) govern the analysis.

Citations and references

• Tax Law § 671(a) - employer withholding obligation for wages, limited to employers maintaining an office or transacting business in New York
• Tax Law § 685(s) - penalty for an individual's baseless false statement that reduces withholding
• N.Y.C. Administrative Code § 11-1771 - parallel New York City employer withholding obligation
• Tax Law Article 30 § 1309 - City PIT withholding to conform, to the greatest extent possible, with State PIT withholding rules
• 20 NYCRR 171.3(a) - amounts treated as wages for federal withholding are also wages for New York State withholding
• 20 NYCRR 171.6(b)(5) - employer may rely on Form IT-2104.1 to determine nonresident status for withholding allocation
• 4 U.S.C. § 114(a) (Public Law 104-95) - bars states from taxing the retirement income of nonresidents/nondomiciliaries, for amounts received after December 31, 1995
• 4 U.S.C. § 114(b)(1)(I)(ii) - defines "retirement income" to include payments after termination of employment under a plan maintained solely to provide benefits exceeding specified IRC contribution/benefit limits
• IRC § 3121(v)(2)(C) - defines a "nonqualified deferred compensation plan"
• Treasury Regulations §§ 31.3401(a)-1(b) and 35.3405-1 (Q&A-21) - treatment of nonqualified plan distributions as wages subject to ordinary wage withholding rather than pension withholding
• The Limited Stores, Inc., TSB-A-00(6)I (Sept. 6, 2000) - prior advisory opinion reaching the same result for a predecessor plan

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2001.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a01_2i.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-01(2)I
Income Tax
May 23, 2001

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I001228B

On December 28, 2000, a Petition for Advisory Opinion was received from Limited Service
Corporation, Three Limited Parkway, Columbus, Ohio 43230.
The issues raised by Petitioner, Limited Service Corporation, 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 are exempt from the personal
   income tax imposed pursuant to Article 22 of the Tax Law (“State PIT”).
2. Whether Petitioner is required to withhold State PIT or New York City personal
   income tax on residents 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
   affiliates of The Limited, Inc. where the affiliates do not have an office or transact business
   in New York State or in New York City, respectively.
3. Whether Petitioner, with regard to distributions made to employees of affiliates of The
   Limited, Inc. where the affiliates have an office or transact business in New York State or
   New York City, respectively, (a) is required to withhold State PIT and City PIT from
   distributions from the Nonqualified Plan, described below, to employees who state that they
   are New York State residents or New York City residents, respectively, (b) is entitled to rely
   upon affidavits it receives from employees regarding their state and city of residence in
   determining whether it is required to withhold State PIT and City PIT from such distributions
   and (c) is subject to a penalty if Petitioner accepts an affidavit that turns out to be false as
   long as Petitioner has no actual knowledge that it is false.
   Petitioner submits the following facts as the basis for this Advisory Opinion.
   Petitioner is a wholly-owned indirect subsidiary of The Limited, Inc. Effective January 1,
   2000, Petitioner adopted a nonqualified deferred compensation plan for certain employees of
   affiliates of The Limited Inc., The Limited Supplemental Retirement and Deferred Compensation
   Plan (the “Nonqualified Plan”). The Nonqualified Plan was adopted to combine two previously
   established nonqualified plans:

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(1) The Limited Supplemental Retirement Plan which provided certain benefits in excess
of the limits imposed by sections 401(a)(17) and 415 of the Internal Revenue Code (“IRC”),
and
(2) The Limited Deferred Compensation Plan which provided certain benefits in excess of
the limits imposed by sections 401(k) and 401(m) of the IRC.
The Nonqualified Plan is a plan described under section 3121(v)(2)(C) of the IRC that solely
provides deferred compensation that is retirement income in excess of the limits imposed by sections
401(a)(17), 415, 401(k) and 401(m) of the IRC. The Nonqualified Plan supplements and
incorporates various definitions and provisions of The Limited Stores, Inc. Savings and Retirement
Plan, a qualified deferred compensation plan for certain employees of The Limited, Inc., and its
affiliates (the “Qualified Plan”).
Section 3.1 of the Nonqualified Plan provides that an employee who is eligible to participate
in the Qualified Plan will automatically become a participant in the Nonqualified Plan, and certain
other management and highly compensated employees may also be eligible to participate in the
Nonqualified Plan, for the purpose of receiving an amount equal to the amount of retirement
contributions not credited to the participant under the Qualified Plan because of the Qualified Plan
limitations, as provided in section 5.4 of the Nonqualified Plan.
Section 4.1 of the Nonqualified Plan provides that an eligible participant may elect to defer
a certain portion of the participant’s compensation. Pursuant to section 5.3 of the Nonqualified Plan,
where a participant makes such election the participant will be credited with an amount equal to two
times the deferred amount.
Section 7.1 of the Nonqualified Plan provides that all distributions from the Nonqualified
Plan made to a participant are paid in a lump sum payment as soon as practicable following the
participant’s termination of employment by The Limited, Inc. or its affiliates, but no earlier than
30 days following the termination of employment.
Section 9.5 of the Nonqualified Plan provides that the right of a participant or beneficiary to
receive a distribution under the plan shall at all times be an unsecured claim against the general
assets of The Limited, Inc. or its affiliates, and neither the participant nor any beneficiary shall have
any right in or against any specific assets of The Limited, Inc. or its affiliates. If a reserve of assets
is established to provide funds for the payment of benefits under the plan, no participant or
beneficiary shall have any ownership rights in or to any reserve.
The Limited Stores, Inc., an indirect subsidiary of The Limited, Inc., previously requested
and received an Advisory Opinion regarding the withholding tax treatment of distributions from The
Limited Supplemental Retirement Plan. (The Limited Stores, Inc., Adv Op Comm T&F,

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September 6, 2000, TSB-A-00(6)I). The opinion held that The Limited Supplemental Retirement
Plan was a plan or arrangement as described in section 3121(v)(2)(C) of the IRC, and the lump sum
distributions from such plan met the requirements of section 114(b)(1)(I)(ii) of Title 4 of the US
Code. The lump sum distributions from the plan received by nonresidents and nondomiciliaries of
New York State were exempt from State PIT. Where affiliates of The Limited, Inc. did not have an
office or transact business in New York State, the petitioner was not required to withhold State PIT
or City PIT from distributions from the plan to employees of those affiliates. However, where an
affiliate of The Limited, Inc. had an office or transacted business in New York State, it was required
to withhold State PIT or City PIT from distributions from the plan to employees who were residents
of New York State, or New York City, respectively. The opinion also held that the petitioner could
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, respectively, that it
received from an employee of an affiliate of The Limited, Inc. to determine whether an employee
was a resident of New York State or New York City, respectively. (Note that Form
IT- 2104.1 has subsequently been revised, and Form IT-2104.2 is now obsolete.)
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
(ii) is a payment received after termination of employment and 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 of 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 of 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”).

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Income Tax
May 23, 2001

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 and nondomiciliaries 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.
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.)
Similarly, Section 11-1771 of the New York City Administrative Code provides that “every
employer maintaining an office or transacting business within this city or state and making payment
... of any wages taxable under this chapter ... shall deduct and withhold from such wages for each
payroll period a tax ...” (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
The Limited, Inc. where the affiliates do not have an office or transact business in New York State.
Likewise, pursuant to section 11-1771 of the New York City Administrative Code, the withholding
of City PIT is not required from such distributions to employees of affiliates of The Limited, Inc.
where the affiliates do not have an office or transact business in New York State.
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.)

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Similarly, section 11-1771 of the New York City Administrative Code provides that “every
employer maintaining an office or transacting business within this city or state and making payment
... of any wages taxable under this chapter ...”. (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 1309 of Article 30 of the Tax Law provides that “a tax imposed pursuant to the
authority of this article shall provide that the tax shall be withheld from the wages of city residents
in the same manner and subject to the same requirements, to the greatest extent possible, as provided
in sections six hundred seventy-one through six hundred seventy-eight of this chapter ....”
Accordingly, payments which are considered wages for purposes of withholding of New York State
personal income tax are also considered wages for purposes of withholding of New York City
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.

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Income Tax
May 23, 2001

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.
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
The Limited, Inc. where the affiliates have an office or transact business in New York but the
employees are nonresidents of New York State, because such distributions are not taxable under
State PIT. (See Issue 1 above.) Since, City PIT is imposed only on residents of New York City,
Petitioner is not required to withhold City PIT from distributions from the Nonqualified Plan where
the employees are nonresidents of New York City.
However, the provisions of section 114 of Title 4 of the US Code, which exempt 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. where the affiliates have an office or transact business in New York State, and the
employees are residents of New York State. Likewise, pursuant to section 11-1771 of the New York
City Administrative Code, withholding of City PIT is required by Petitioner from distributions from
the Nonqualified Plan that are made to employees of affiliates of The Limited, Inc. where the
affiliates have an office or transact business in New York State, and the employees are residents of
New York City.
Further, 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. Therefore, Petitioner may rely on Form IT-2104.1 - New York State,
City of New York and City of Yonkers Certificate of Nonresidence and Allocation of Withholding
Tax (the old Form IT -2104.1 - New York State Certificate of Nonresidence and Allocation of
Withholding Tax may be used if the employer already has it on file), and Form IT-2104.2 - City of
New York Certificate of Nonresidence (although obsolete, this form may be used if the employer
already has it on file) that Petitioner receives from an employee of an affiliate of The Limited, Inc.
to determine that the employee is not a resident of New York State or New York City in determining
whether it is required to withhold State PIT and City PIT, as applicable, from the distributions from
the Nonqualified Plan that are made to such employee.
Finally, where Petitioner relies on Form IT-2104.1 (both old and new) or Form IT-2104.2
no penalty will be asserted if the Form that Petitioner relies on contains false information if

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Petitioner has no knowledge that it is false. However, pursuant to section 685(s) of the Tax Law,
where an individual makes a statement under section 671 of the Tax Law which results in a decrease
in the amounts deducted and withheld under State PIT or City PIT, respectively, and as of the time
such statement was made, there was no reasonable basis for such statement, such individual may be
subject to the penalty imposed under section 685(s) of the Tax Law.

DATED: May 23, 2001

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist III
Technical Services Division

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