Do periodic distributions from an unfunded, nonqualified deferred compensation plan sponsored by a former employer qualify for New York's $20,000 pension and annuity income subtraction?

Plain-English summary

A petitioner had an unfunded, nonqualified deferred compensation plan (the Plan) with his former employer: an agreement under which he performed services in exchange for the employer's promise to pay him over time once he met certain conditions, such as reaching a specified age. Petitioner, who had already turned 59½, was receiving periodic distributions from the Plan and would continue to for at least ten years. He asked whether these distributions qualified for New York's $20,000 pension and annuity income subtraction under Tax Law § 612(c)(3-a), and if so, how to report them.

The Department concluded the distributions did qualify. It walked through a two-step analysis: first, how should the Plan distributions be characterized, and second, do they count as "pensions and annuities" income under Tax Law § 612(c)(3-a)? On the first point, the Department explained that a single payment can be "wages" for federal employment-tax purposes (FICA/FUTA, under IRC §§ 3121(a) and 3306(b)) while simultaneously being "compensation" for federal income-tax purposes under IRC § 83, because those wage definitions apply only within their own IRC chapters and don't control how a payment is characterized for income tax.

On the second point, the Department looked to Tax Law § 612(c)(3-a), which allows a subtraction of up to $20,000 for compensation included in federal adjusted gross income (FAGI) if the recipient is at least 59½ and the money is paid periodically and is attributable to personal services performed prior to retirement. Because Petitioner's Plan payments were made only after his separation from service, were paid annually, and he had already reached 59½, the Department found they qualified as pension payments within the meaning of that section - regardless of the fact that the same amounts were also reported as wages on his Form W-2 for FICA/FUTA purposes.

The Department also distinguished this result from an earlier Division of Tax Appeals case, Matter of Flanter, which involved a different kind of plan (an old IRC former § 457 plan) whose payments were deemed "wages" under a now-superseded version of the IRC and were therefore ineligible for the subtraction - a result Congress mooted in 2001 by amending IRC § 3401(a)(12)(E). The Department instead followed the reasoning in Matter of Bourns and Matter of Musliner, which held that W-2 reporting alone does not disqualify a distribution from being pension and annuity income.

What this means for you

If you receive payments from a former employer's nonqualified deferred compensation plan

Once you've reached age 59½ and your plan payments are periodic, attributable to your prior services, and paid only after you've separated from employment, they can qualify as pension and annuity income for New York purposes - even if your former employer reports the same amounts as wages on your Form W-2 (as is typical for FICA/FUTA purposes on nonqualified plans). You can claim the Tax Law § 612(c)(3-a) subtraction (up to $20,000, combined with any other pension and annuity income) and should report the box 11 amount from your W-2 as pension income on your New York return.

Accountants and tax professionals

Don't let W-2 wage reporting on a nonqualified deferred compensation distribution automatically rule out the § 612(c)(3-a) subtraction for a client. The Department's position (consistent with Bourns and Musliner) is that FICA/FUTA "wage" characterization and income-tax "pension" characterization are governed by different IRC provisions and can coexist for the same payment. Confirm the client's age (59½+), that payments are periodic, and that they're attributable to pre-retirement services and paid post-separation.

Common questions

Q: Does reporting a distribution as wages in box 11 of a W-2 disqualify it from the pension subtraction?
A: No. The Department held that FICA/FUTA wage characterization (under IRC §§ 3121(a) and 3306(b)) is limited to those specific IRC chapters and doesn't control how the same payment is characterized for income tax purposes; the payment can still be pension and annuity income under Tax Law § 612(c)(3-a).

Q: What conditions must be met for a nonqualified deferred compensation distribution to qualify for the $20,000 subtraction?
A: The recipient must be at least 59½, the payments must be periodic, and they must be attributable to personal services performed prior to retirement from employment, arising from an employer-employee relationship, per Tax Law § 612(c)(3-a).

Q: How should the qualifying distributions be reported on a New York return?
A: The amount listed in box 11 of the federal Form W-2 received from the plan should be reported to New York State as pension income.

Q: Why did the Department distinguish this Plan from the one in Matter of Flanter?
A: Flanter involved distributions from an IRC former § 457 plan that, under the law then in effect, were deemed "wages" for income tax purposes and so were ineligible for the subtraction. That result was mooted after the Federal Economic Growth and Tax Relief Reconciliation Act of 2001 amended IRC § 3401(a)(12)(E). Petitioner's Plan is instead governed by IRC § 83, which characterizes the payments as "compensation," not wages, for income tax purposes.

Citations and references

• Tax Law § 612(c)(3-a) - $20,000 subtraction for pension and annuity income of individuals 59½ or older whose payments are periodic and attributable to pre-retirement services
• Tax Law § 612(c)(3)(i) - subtraction for pensions paid to New York State and local government officers and employees
• Tax Law § 612(c)(3)(ii) - subtraction for pensions paid to federal government officers and employees
• IRC § 83 and 26 CFR § 1.83-1(a)(1) - taxation of property transferred in exchange for services (governs unfunded nonqualified deferred compensation plans not subject to IRC § 409A)
• IRC § 409A - constructive receipt rules for nonqualified deferred compensation that fails specified statutory criteria (not at issue in this opinion)
• IRC §§ 3121(a) and 3306(b) - define "wages" for FICA and FUTA employment-tax purposes only
• IRC § 3401(a)(12)(E) - excludes IRC § 457 plan payments from wages, added by the Federal Economic Growth and Tax Relief Reconciliation Act of 2001 (Pub. L. 107-16)
• IRC § 61(a)(1) and 26 CFR § 1.61-2(a)(1) - gross income includes compensation for services, retired pay, pensions, and retirement allowances
• Matter of Bourns, DTA No. 821404 (Feb. 21, 2008); Matter of Musliner, DTA No. 821426 (Mar. 13, 2008) - W-2 reporting alone does not defeat pension and annuity characterization
• Matter of Flanter, DTA No. 818698 (Aug. 22, 2002), aff'd Tax Appeals Tribunal (Feb. 27, 2003) - distinguished, involved a pre-2001 IRC former § 457 plan

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2010.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a10_1i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-10(1)I
Income Tax
February 10, 2010

Office of Counsel
Advisory Opinion Unit
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I090617A

Petitioner name redacted, in a petition dated June 17, 2009, requests an advisory opinion
regarding whether the distributions from a nonqualified deferred compensation plan consisting of an
unfunded contractual promise to make payments in the future (the Plan) that is sponsored by his former
employer (Employer) qualify for the $20,000 income subtraction under Tax Law section 612(c)(3-a). If it
is determined that the distributions qualify for the income subtraction, Petitioner further requests guidance
concerning how the distributions should be reported on his New York State Personal Income Tax return.
We conclude that, because the Plan distributions qualify as pension income, the $20,000 income
subtraction under Tax Law section 612(c)(3-a) is allowable. The amount listed in box 11 of the Federal
form W-2 that Petitioner receives from the Plan should be reported to New York State as pension
income.
Facts
The Plan is an unfunded contractual agreement between Petitioner and his former Employer
under which Petitioner provided services to Employer in exchange for Employer’s promise that Petitioner
would receive payment for such services over a period of time after he met certain qualifications, such as
age. Petitioner, who has attained the age of 59 ½, receives distributions from the Plan. The payments
from the Plan are periodic and will continue for at least ten years.
Analysis
Section 612 of the Tax Law provides that the New York adjusted gross income of a resident
individual is the individual’s Federal adjusted gross income (FAGI) with the modifications specified in
section 612. Tax Law section 612(c)(3)(i) provides a subtraction modification for pensions paid to
officers and employees of New York State, its subdivisions and agencies, to the extent included in FAGI,
while Tax Law section 612(c)(3)(ii) provides a similar subtraction for pensions paid to officers and
employees of the United States, the District of Columbia, any territory, possession or political subdivision
of any territory or possession. Additionally, up to $20,000 of income that was included in FAGI due to
distributions from pensions and annuities that are not subject to the subtraction modifications provided by
Tax Law section 612(c)(3) are eligible for the subtraction modification provided by Tax Law section
612(c)(3-a) if the taxpayer is at least 59 ½, and the distributions are “periodic payments attributable to
personal services performed by such individual prior to his retirement from employment, which arise (i)
from an employer-employee relationship.” (Tax Law § 612[c][3-a].)
While not binding on the Department, in two determinations issued by the Division of Tax
Appeals Matter of Bourns (DTA No. 821404 [February 21, 2008]) and Matter of Musliner (DTA No.
821426 [Small Claims Determination, March 13, 2008]), distributions from similar nonqualified plans
were found to constitute pension and annuity income that is eligible for the subtraction modification
provided by Tax Law section 612(c)(3-a). In both Bourns and Musliner, the Department argued that the

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Income Tax
February 10, 2010

distributions were reported to the taxpayers on Federal Form W-2, which evidenced that the payments
constituted wages and, thus, were not eligible for the pension and annuity income subtraction
modification afforded by Tax Law section 612(c)(3-a).
A different conclusion was reached in Matter of Flanter, (DTA No. 818698 [August 22, 2002],
aff’d Tax Appeals Tribunal [February 27, 2003]) where the distributions at issue were made by an
Internal Revenue Code (IRC) former section 457 plan. In Flanter, the Administrative Law Judge
concluded that pursuant to the Internal Revenue Code and Treasury Regulations (26 C.F.R.), distributions
from an IRC former section 457 plan were deemed to be wages, not payments from a pension or annuity,
and, thus, were not eligible for the subtraction modification afforded by Tax Law section 612(c)(3-a).
Flanter has been rendered moot since the Federal Economic Growth and Tax Relief Reconciliation Act of
2001 (Pub. Law 107-16) amended IRC section 3401 to provide that remuneration paid to an employee
under an IRC 457 plan does not constitute wages for IRC Chapter 24 purposes. See IRC §3401(a)(12)(E).
The issue presented requires a two-step analysis. First, what is the proper characterization of the
distributions received from the Plan? Second, do distributions from the Plan constitute “pensions and
annuities” income within the purview of Tax Law § 612(c)(3-a)?
Characterization of the Distributions from the Plan
The question of whether deferred compensation distributed from a retirement plan can be
characterized as both “wages” and “pension and annuity” income was addressed in Flanter, Bourns and
Musliner. In Flanter, the Administrative Law Judge concluded that distributions from an IRC former
§ 457 plan could not be “pension and annuity” income because the distributions were “wages” pursuant to
IRC section 3401(a) as it existed prior to the enactment of the Federal Economic Growth and Tax Relief
Reconciliation Act of 2001 (Pub. Law 107-16). The Administrative Law Judge in Bourns specifically
rejected the argument that any distributions that are “wages” for income tax withholding purposes cannot
also be characterized as “pensions and annuities” income within the purview of Tax Law section
612(c)(3-a).
Amounts deferred under a nonqualified deferred compensation plan are considered to be “wages”
for the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA),
which are IRC Subtitle C Employment Taxes. (See, IRC §§ 3121[a], and 3306[b].) Each of these
employment taxes is individually codified in a specific Chapter of the IRC. (See, IRC Subtitle C, Chapters
21 and 23.) Each Chapter includes a definition of “wages” that, through the use of language “[f]or
purposes of this chapter,” is limited to that specific Chapter of the IRC. (IRC §§ 3121[a] and 3306[b].)
Due to the statutory limitations placed on the applicability of these definitions, they cannot be relied upon
to determine the character of distributions for income tax (IRC Subtitle A) purposes.
For Federal income tax purposes, the taxation of unfunded nonqualified deferred compensation
plans is governed by IRC sections 83 and 409A.1 Section 409A, which includes provisions for the
constructive receipt and recognition of all unrecognized deferred compensation when a nonqualified plan
fails to meet specified statutory criteria, is not at issue here. Thus, the Plan is taxable pursuant to IRC
section 83. Pursuant to IRC section 83, property that is transferred to a person in exchange for the
provision of services is included in the person’s gross income as compensation in the first taxable year
1

If the Plan had been funded through either a nonexempt trust or the use of an annuity, the provisions of IRC
sections 402(b) or 403(c), respectively, would also apply to the Plan.

TSB-A-10(1)I
Income Tax
February 10, 2010

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that either (i) the person’s right to the property is not subject to a substantial risk of forfeiture or (ii) the
person’s rights in the property are transferrable. (IRC § 83[a]; 26 CFR § 1.83-1[a][1].)
Accordingly, each amount taxable to Petitioner will be characterized based upon the provision of
the IRC under which the tax is imposed. For FICA and FUTA the amounts are characterized as “wages.”
For income tax purposes, the amounts included in Petitioner’s income are characterized as
“compensation.” Thus, a single distribution from the Plan could constitute both “wages” for employment
tax purposes and “compensation” for income tax purposes. (See, Rev. Rul 2007-48, I.R.B. 2007-30 [July
23, 2007].)
“Pensions and Annuities” Income Pursuant to Tax Law section 612(c)(3-a)
For New York State residents, the starting point for the computation of personal income tax
liability is FAGI. (Tax Law § 612.) Gross income includes “[c]ompensation for services, including fees,
commissions, fringe benefits, and similar items.” (IRC § 61[a][1]). The Treasury Regulations interpret
IRC section 61(a)(1) to include, among other things, wages, “retired pay of employees, pensions, and
retirement allowances.” (See, 26 CFR § 1.61-2[a][1]). FAGI is defined as gross income minus the
deductions prescribed by IRC section 62, none of which are relevant to this opinion. (IRC § 62.) Thus,
although not wages, the Plan distributions are part of FAGI and are taxable unless subject to a New York
subtraction modification.
Section 612(c)(3-a) provides a subtraction modification up to $20,000 for compensation included
in FAGI if the recipient has attained the age of fifty-nine and one-half and if the money is paid in
periodic payments and is attributable to personal services performed by the recipient for his or her
employer prior to retirement. The amounts that Petitioner receives from the Plan are only paid after his
separation from service to his employer and are paid annually in the month of January. Since Petitioner
has attained the age of fifty-nine and one-half, these payments qualify as pension payments.
Accordingly, the distributions received by Petitioner from the Plan constitute “pensions and annuities”
income within the purview of Tax Law §612(c)(3-a) and are eligible for the subtraction modification
afforded by such section to the extent that the distributions, when added to any other pension and annuity
income, do not exceed $20,000 and were included in Petitioner’s FAGI. Petitioner will report the
distributions received from the Plan as pensions and annuities income.

DATED: February 10, 2010

NOTE:

/S/
Jonathan Pessen
Director of Advisory Opinions
Office of Counsel

An Advisory Opinion is issued at the request of a person or entity. It is limited to
the facts set forth therein and is binding on the Department only with respect to
the person or entity to whom it is issued and only if the person or entity fully and
accurately describes all relevant facts. An Advisory Opinion is based on the law,
regulations, and Department policies in effect as of the date the Opinion is issued
or for the specific time period at issue in the Opinion.