Is a lump-sum distribution from an employer's nonqualified supplemental retirement plan taxable New York source income when it's paid to someone who becomes a nonresident before receiving it?

Plain-English summary

Patrick G. Calhoun, the Chief Executive Officer of the State Employees Federal Credit Union (SEFCU), asked New York whether a lump-sum payment from SEFCU's Supplemental Retirement Plan (referred to as the Nonqualified Plan) would count as New York source income once he became a nonresident. SEFCU also maintained a tax-qualified profit-sharing plan (the PSP) for Calhoun, but federal limits under IRC §§ 401(a)(17) and 415 capped how much he could receive under that plan. The Nonqualified Plan was designed to make up the difference: it promised a lump sum equal to $3,400,000 minus his PSP account balances, payable after termination of employment for any reason other than death or disability, subject to possible reduction and forfeiture. His right to the payment was only an unsecured claim against SEFCU's general assets, not a claim to any specific asset.

The Department's analysis turned on federal law, not just New York's own rules. Ordinarily, Tax Law § 601(e) taxes a nonresident on their New York source income, and Tax Law § 631(a)-(b) defines that source income to include amounts connected with a New York business, trade, profession, or occupation. But 4 U.S.C. § 114(a) - part of a federal statute governing state taxation of retirement income - bars any state from taxing the "retirement income" of someone who is not a resident or domiciliary of that state. Section 114(b) defines "retirement income" to include payments from a plan described in IRC § 3121(v)(2)(C) (a nonqualified deferred compensation arrangement) when the payment is received after termination of employment under a plan maintained solely to provide retirement benefits in excess of limits like those in IRC §§ 401(a)(17) and 415.

The Department found that the Nonqualified Plan fit that description: it was maintained by SEFCU solely to give Calhoun a retirement benefit beyond what the PSP could provide because of the 401(a)(17) and 415 caps. Assuming the Nonqualified Plan is indeed a plan described in IRC § 3121(v)(2)(C), the lump-sum payment qualifies as "retirement income" under 4 U.S.C. § 114(b). Since Calhoun would be a nonresident of New York when he received it, only his state of residence or domicile - not New York - could tax that income. The Department was careful to note the conclusion rests entirely on that IRC § 3121(v)(2)(C) assumption; if the Nonqualified Plan turned out not to meet that description, the ruling would not apply.

What this means for you

Executives and highly compensated employees with excess-benefit plans

If your employer maintains a nonqualified "excess benefit" or supplemental retirement plan designed solely to replace amounts you cannot receive from a qualified plan because of IRC limits (such as §§ 401(a)(17), 401(k), 401(m), 402(g), 403(b), 408(k), or 415), a lump-sum payout after you terminate employment may qualify as federally protected "retirement income" under 4 U.S.C. § 114. If you are a nonresident of New York when you receive it, New York cannot tax it as New York source income - only your state of residence or domicile can.

Employers designing nonqualified deferred compensation plans

The exemption depends on the plan's purpose and structure matching IRC § 3121(v)(2)(C) and the "excess benefit" description in 4 U.S.C. § 114(b)(1)(I): the plan must be maintained solely to provide retirement benefits above the statutory qualified-plan limits, and payment must come after termination of employment. Plan documents that clearly tie the benefit formula to the participant's foregone qualified-plan benefits (as SEFCU's plan tied the lump sum to the PSP account balance) support that characterization.

Common questions

Q: Does this mean all nonqualified deferred compensation is exempt from New York tax for nonresidents?
A: No. The exemption in 4 U.S.C. § 114 is narrow - it only reaches "retirement income" as federally defined, including payments under a plan described in IRC § 3121(v)(2)(C) that is maintained solely to provide benefits in excess of specific qualified-plan limits, paid after termination of employment. A nonqualified deferred comp plan that doesn't fit that description could still be taxable New York source income under Tax Law § 631.

Q: Why did the Department repeatedly say its conclusion was based on an "assumption"?
A: The petitioner asked the Department to assume the Nonqualified Plan was a plan described in IRC § 3121(v)(2)(C). The Department expressly conditioned its ruling on that assumption, stating that if it isn't true, the ruling's conclusions do not apply.

Q: What was the role of the PSP (profit-sharing plan) in this ruling?
A: The PSP was the tax-qualified plan whose contributions and benefits were limited by IRC §§ 401(a)(17) and 415. The Nonqualified Plan's lump-sum benefit was calculated as $3,400,000 minus the petitioner's PSP account balances, which is what showed the Nonqualified Plan existed solely to make up for those qualified-plan limits.

Q: Does the petitioner's residency status at the time of payment matter?
A: Yes. The ruling depends on the petitioner being a nonresident of New York when the Nonqualified Plan benefits are actually received. The federal preemption in 4 U.S.C. § 114(a) protects "an individual who is not a resident or domiciliary" of the taxing state at that time.

Citations and references

• Tax Law § 601(e) - imposes personal income tax on a nonresident's New York source income, computed using the New York source fraction
• Tax Law § 631(a) - defines New York source income of a nonresident as items connected with New York sources plus related modifications
• Tax Law § 631(b)(1) - treats income from a business, trade, profession, or occupation carried on in New York as New York source income
• 4 U.S.C. § 114(a) - bars a state from taxing the retirement income of someone who is not its resident or domiciliary
• 4 U.S.C. § 114(b)(1)(I) - defines "retirement income" to include payments from an IRC § 3121(v)(2)(C) plan maintained solely to provide benefits exceeding certain qualified-plan limits
• IRC § 3121(v)(2)(C) - defines "nonqualified deferred compensation plan"
• IRC §§ 401(a)(17) and 415 - qualified-plan contribution/benefit limits that the Nonqualified Plan was designed to supplement

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2006.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a06_4i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-06(4)I
Income Tax
June 13, 2006

Office of Tax Policy Analysis
Technical Services Division
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I051021A

On October 21, 2005, a Petition for Advisory Opinion was received from Patrick G.
Calhoun, c/o Brian P. Goldstein, Esq., P.O. Box 12189, Albany, New York 12212-2189.
The issue raised by Petitioner, Patrick G. Calhoun, is whether the payment of a lump-sum
distribution from the State Employees Federal Credit Union (SEFCU) Supplemental Retirement
Plan (the Nonqualified Plan) to a nonresident of New York State constitutes New York source
income for New York State personal income tax purposes.
Petitioner submits the following facts as the basis for this Advisory Opinion.
SEFCU is a federal credit union exempt from federal income tax pursuant to section
501(c)(1) of the Internal Revenue Code (IRC). SEFCU employs Petitioner as its Chief Executive
Officer. It is assumed that Petitioner will become a nonresident of New York prior to the receipt
of the Nonqualified Plan benefits.
SEFCU maintains a profit-sharing plan (the PSP) that, according to Petitioner, qualifies
for favorable tax treatment under section 401(a) of the IRC. As such, it is assumed for purposes
of this Opinion that the PSP is subject to the limitations imposed under sections 401(a)(17) and
415 of the IRC and the nondiscrimination requirements under section 401(a)(4) that could limit
the contributions and benefits Petitioner could receive under the PSP.
SEFCU also maintains the Nonqualified Plan for the benefit of Petitioner. For purposes
of this Opinion, it is assumed that the Nonqualified Plan is a plan described in section
3121(v)(2)(C) of the IRC. Petitioner is the sole participant in the Plan.
Section 2.1 of the Nonqualified Plan provides that upon termination of employment on or
after his retirement date for any reason other than death or disability, a lump-sum payment equal
to $3,400,000 less the amount of Petitioner’s account balances under PSP will be payable to
Petitioner as soon as administratively feasible. The benefits described in the preceding sentence
are subject to reduction under certain circumstances described in the Nonqualified Plan
agreement. In each instance where a reduction would apply, the amount of the reduced benefit is
further reduced by the amount of Petitioner’s account balances under PSP. Petitioner’s benefits
under the Nonqualified Plan are also subject to forfeiture under certain circumstances.
Section 4.1 of the Nonqualified Plan provides that the right of Petitioner or his designated
beneficiary to receive a distribution from the plan shall be an unsecured claim against the general
assets of SEFCU, and neither Petitioner nor his designated beneficiary shall have any rights in or
against any specific assets of SEFCU.

-2­
TSB-A-06(4)I
Income Tax
June 13, 2006
Applicable law and regulations
Section 3121(v)(2)(C) of the IRC provides:
Nonqualified deferred compensation plan. For purposes of this paragraph, the
term "nonqualified deferred compensation plan" means any plan or other arrangement for
deferral of compensation other than a plan described in subsection (a)(5).
Section 114 of Title 4 of the US Code provides, in part:
(a) No 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).
(b) For purposes of this section –
(1) The term “retirement income” means any income from –
*

*

*

(I) any plan, program, or arrangement described in section 3121(v)(2)(C) of such
Code, if such income –
(i) is part of a series of substantially equal periodic payments (not less frequently
than annually) made for –
(I) the life or life expectancy of the recipient (or the joint lives or joint life
expectancies of the recipient and the designated beneficiary of the recipient), or
(II) a period of not less than 10 years, 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 such Code or any other limitation on contributions or benefits in such Code on
plans to which any of such sections apply. . . .
Section 601(e) of the Tax Law imposes a personal income tax on nonresidents of
New York State who have New York source income and provides, in part:
Nonresidents and part-year residents. (1) General. There is hereby imposed for
each taxable year on the taxable income which is derived from sources in this state of
every nonresident and part-year resident individual . . . a tax which shall be equal to the
tax base multiplied by the New York source fraction.

-3­
TSB-A-06(4)I
Income Tax
June 13, 2006
(2) Tax base. The tax base is the tax computed under subsections (a) through (d)
of this section, as the case may be, reduced by the credits permitted under subsections (b),
(c), (d) and (m) of section six hundred six, as if such nonresident or part-year resident
individual . . . were a resident subject to the provisions of part II of this article.
(3) New York source fraction. The New York source fraction is a fraction the
numerator of which is such individual's . . . New York source income determined in
accordance with part III of this article and the denominator of which is such individual's
New York adjusted gross income determined in accordance with part II of this article. . . .
Section 631 of the Tax Law provides, in part:
(a) General. The New York source income of a nonresident individual shall be
the sum of the following: (1) The net amount of items of income, gain, loss and deduction
entering into his federal adjusted gross income, as defined in the laws of the United States
for the taxable year, derived from or connected with New York sources . . . and
(2) The portion of the modifications described in subsections (b) and (c) of
section six hundred twelve which relate to income derived from New York sources. . . .
(b) Income and deductions from New York sources.
(1) Items of income, gain, loss and deduction derived from or connected with
New York sources shall be those items attributable to:
(A) the ownership of any interest in real or tangible personal property in this state;
or
(B) a business, trade, profession or occupation carried on in this state; . . .
Opinion
Section 601(e) of the Tax Law imposes a personal income tax on the taxable income
derived from New York sources of a nonresident individual. The tax is equal to the tax
computed as if the nonresident individual were a New York State resident for the entire year,
reduced by certain credits, and then multiplied by the income percentage (i.e., New York source
fraction). The numerator of the fraction used to compute the income percentage is the
individual’s New York source income; the denominator of the fraction is the nonresident
individual’s New York adjusted gross income from all sources for the entire year.
Section 631(a) of the Tax Law provides that the New York source income of a
nonresident individual is the sum of the items of income, gain, loss and deduction entering into
federal adjusted gross income derived from or connected with New York sources and any
New York addition and subtraction modifications under sections 612(b) and (c) of the Tax Law
that relate to income derived from New York sources.

-4­
TSB-A-06(4)I
Income Tax
June 13, 2006

Section 114 of Title 4 of the US Code provides that only the state of which a person is a
resident or domiciliary may tax the person on his or her retirement income. Section 114(b)
provides that retirement income includes income received from any plan, program, or
arrangement described in section 3121(v)(2)(C) of the IRC, if such income 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 one 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 such Code on plans to which any such sections apply.
The Nonqualified Plan provides that upon termination of employment on or after
Petitioner’s retirement date for any reason other than death or disability, a lump-sum payment
equal to $3,400,000 less the amount of Petitioner’s account balances under PSP will be payable
to Petitioner. The benefits are subject to reduction under certain circumstances described in the
Nonqualified Plan agreement. However, in each instance where a reduction would apply, the
amount of the reduced benefit is further reduced by the amount of Petitioner’s account balances
under PSP.
It appears that the Nonqualified Plan is maintained by SEFCU solely for the purpose of
providing Petitioner a retirement benefit in excess of the limitations imposed on Petitioner’s PSP
under sections 401(a)(17) and 415 of the IRC. Accordingly, assuming that the Nonqualified Plan
is a plan described in section 3121(v)(2)(C) of the IRC, the lump-sum distribution from the
SEFCU Nonqualified Plan paid to Petitioner would be retirement income for purposes of section
114(b) of Title 4 of the US Code. Section 114 of Title 4 of the US Code provides that only the
state of which an individual is a resident or domiciliary may tax the individual on his or her
retirement income. Therefore, since Petitioner will be a nonresident of New York prior to the
receipt of the Nonqualified Plan benefits, a payment made to Petitioner from the Nonqualified
Plan is not New York source income for New York State personal income tax purposes.
However, these conclusions are based on the assumption that the Nonqualified Plan is a plan
described in section 312 (v)(2)(C) of the IRC. If this is not true, then the conclusions reached in
this Opinion do not apply.

DATED: June 13, 2006

NOTE:

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

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