Are the 10-year installment payments a company makes from its nonqualified deferred compensation plan to two former employees, who are now nonresidents of New York, subject to New York personal income tax and withholding?

Plain-English summary

Petitioner (a New York employer, name redacted) maintains a Supplemental Deferred Compensation Plan (the Plan) for former employees. Two of those former employees performed services for Petitioner in New York, deferred part of their earnings into the Plan, and then retired and established a domicile outside New York before distributions began. Petitioner asked whether it had to withhold New York State personal income tax from the distributions it was paying them.

The Plan offered participants a choice of payout forms - up to ten annual installments, a single lump sum, or a partial lump sum combined with installments - locked in by a Participation Agreement that became irrevocable after retirement. Both employees at issue had chosen to receive their benefits as annual installments spread over a 10-year period. Petitioner had stopped withholding New York tax on these payments, believing they were shielded by a federal statute that bars states from taxing the retirement income of people who are not residents or domiciliaries of that state.

The Department agreed. Under 4 U.S.C. § 114(a), no state may tax the "retirement income" of someone who is not a resident or domiciliary of that state. "Retirement income" is defined in 4 U.S.C. § 114(b)(1)(I) to include payments from a nonqualified deferred compensation plan (as defined in IRC § 3121(v)(2)(C)) when the payments are part of a series of substantially equal periodic payments made at least annually, either for life/life expectancy or over a period of at least 10 years. Because each employee's Plan payments were annual, substantially equal installments over exactly a 10-year period, the Department concluded the distributions met that definition.

As a result, the distributions to these two former employees - now nonresidents and non-domiciliaries of New York - are exempt from New York State income tax and from New York State income tax withholding, and Petitioner's decision not to withhold was correct.

What this means for you

Employers administering nonqualified deferred compensation plans

If a former employee elects a payout schedule of substantially equal annual installments over at least 10 years (or for life/life expectancy), and that person is a nonresident and non-domiciliary of New York when the payments are made, federal law preempts New York's authority to tax or require withholding on those payments. A single lump-sum payment, or a schedule that doesn't meet the "substantially equal" or minimum-duration test, would not automatically get this protection.

Former New York employees who are now nonresidents

The exemption turns on how you structured your payout election, not on where you worked before retiring. Choosing (and locking in, via an irrevocable post-retirement election) an annual installment schedule of at least 10 years is what qualifies the payments as "retirement income" under federal law - even though the compensation itself was originally earned for New York services.

Common questions

Q: Does this exemption require the plan to be a "qualified" ERISA plan?
A: No - the opposite. The federal definition of "retirement income" in this context specifically covers nonqualified deferred compensation plans under IRC § 3121(v)(2)(C), which are plans other than ERISA/qualified plans described in IRC § 3121(a)(5).

Q: What made these particular distributions qualify as "retirement income"?
A: Each employee irrevocably elected, in a Participation Agreement, to receive annual installment payments over a 10-year period - substantially equal periodic payments made at least annually for a period of not less than 10 years, which is exactly what 4 U.S.C. § 114(b)(1)(I) requires.

Q: Would a lump-sum distribution from the same Plan get the same treatment?
A: The opinion doesn't address that scenario directly, since both employees here chose the 10-year installment option; a lump sum would need to independently satisfy the "substantially equal periodic payments" requirement to qualify as retirement income under the federal statute.

Q: Was Petitioner right to stop withholding New York tax on these payments?
A: Yes. The Department confirmed the distributions are exempt from both New York State income tax and New York State income tax withholding once the recipients are nonresident, non-domiciliary former employees receiving qualifying retirement income.

Citations and references

• 4 U.S.C. § 114(a) - bars a state from taxing the retirement income of an individual who is not a resident or domiciliary of that state
• 4 U.S.C. § 114(b)(1)(I) - defines "retirement income" to include nonqualified deferred compensation plan payments made as substantially equal periodic payments, at least annually, for life/life expectancy or a period of at least 10 years
• IRC § 3121(v)(2)(C) - defines "nonqualified deferred compensation plan"
• IRC § 3121(a)(5) - excludes ERISA/"qualified" plans from that definition

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2011.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a11_10i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-11(10)I
Income Tax
November 17, 2011

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

PETITION NO. I110614B

The Department of Taxation and Finance received a Petition for Advisory Opinion from
the Petitioner’s name and address redacted. Petitioner asks whether distributions from a
nonqualified deferred compensation plan to two nonresident former employees are subject to the
personal income tax only in the states in which the former employees currently reside. We
conclude that the distributions from Petitioner’s nonqualified deferred compensation plans (the
Plans) are exempt from New York State income tax withholding, because a federal statute
prohibits the imposition of state income taxes on retirement income of an individual who is not a
resident or domiciliary of such State.
Facts
Petitioner maintains several nonqualified deferred compensation plans for its former
employees, including two employees who are the subject of this Advisory Opinion. Prior to their
retirement, the employees performed services for Petitioner in New York and deferred a part of
their earnings into Petitioner’s Supplemental Deferred Compensation Plan (the Plan). Upon
retiring, each of the employees at issue established a domicile outside of New York and began
receiving distributions from the Plan.
The Plan provided retirement, disability, and termination benefits for its participating
employees, as well as a death benefit payable prior to termination. The Plan also allowed a
participant to elect early withdrawals prior to termination, to specify the amount, and
subsequently to elect to change the payment amount and/or the payment date for that early
withdrawal. Discretionary hardship distributions were also provided for in the Plan.
During their employment with Petitioner, the employees were allowed to designate one
of three forms of payments from the Plan from which retirement distributions would occur after
their termination:
•
•
•

In up to ten annual installments, as designated by the Participant; or
In a single lump-sum payment; or
In a combination of a partial lump-sum payment and up to ten annual installments, as
designation by the Participant.

Once a form of payment was chosen, the Petitioner and each employee entered into a
Participation Agreement that contractually locked in the choice. Under certain circumstances
prior to retirement, the employee was allowed to change his payment form designation, but the

-2-

TSB-A-11(10)I
Income Tax
November 17, 2011

election was irrevocable after retirement. Both employees at issue in this Advisory Opinion
entered into Participant Agreements specifying that their respective annual benefit payments
would be paid over a 10-year period of time. When payments commenced, Petitioner did not
withhold New York State income taxes from these distributions under the belief that the
distributions qualified for a state income tax exemption provided in federal law.
Analysis
Section 114(a) of Title 4 of the U.S. Code provides that no state may impose an income
tax on any retirement income of an individual who is not a resident or domiciliary of such State.
“Retirement income” under 4 U.S.C.S. §114(b)(1)(I) means any plan, program, or arrangement
described in IRC §3121(v)(2)(C), if such income 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 (ii) a period of not less than 10 years.1 IRC §3121(v)(2)(C) defines a “nonqualified
deferred compensation plan” as any plan or other arrangement for deferral of compensation other
than a plan described in IRC §3121(a)(5) (generally, ERISA or “qualified” plans). The Plan
appears to fit within the definition of a “nonqualified deferred compensation plan.” For purposes
of this Advisory Opinion, we will assume that Petitioner’s Plan is a plan described in IRC
§3121(v)(2)(C).
In order to qualify as “retirement income” under 4 U.S.C.S. §114, the Plan must also
make distributions as part of a series of substantially equal periodic payments (made not less
frequently than annually) for the life or life expectancy of the recipient…or a period of not less
than 10 years. The employees at issue in this Advisory Opinion both elected in their respective
Participation Agreements to take annual distributions from the Plan as part of a series of
substantially equal installment payments made over a 10-year period. Thus, we conclude that
the payments conform to the definition of “retirement income” under 4 U.S.C.S. §114(b)(1)(I). As
such, they are not subject to New York State income taxes and New York State income tax
withholding.

DATED: November 17, 2011

NOTE:

1

/S/
DEBORAH R. LIEBMAN
Deputy 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.

4 U.S.C.S. §114(b)(1)(I).