Richard C. Spaulding, a retired 61-year-old New York State employee receiving annual distributions from the New York State Deferred Compensation Plan (funded through IRC § 457 salary deferrals), asked whether those distributions qualify for the Tax Law § 612(c)(3-a) $20,000 pension-and-annuity exclusion available to individuals age 59 1/2 or older - even though the plan administrator labeled his first payment an 'annuity payment.'

Plain-English summary

Richard C. Spaulding, a 61-year-old retiree from New York State employment, had deferred part of his salary during his career under IRC § 457, the federal provision for "Deferred Compensation Plans With Respect To Service For State And Local Governments." Upon retiring, he elected to receive his accumulated deferred compensation in annual installments spread over nine years, starting September 30, 1987. The company administering the New York State Deferred Compensation Plan labeled his first installment an "annuity payment" - and Spaulding asked whether that meant the payments qualified for Tax Law § 612(c)(3-a)'s $20,000 pension-and-annuity exclusion available to New York taxpayers age 59 1/2 or older.

The Department said no, and the reasoning is the counterintuitive core of this opinion: what the plan administrator (or the taxpayer) calls a payment does not control its tax character. Federal law settles the question first. IRC § 457(a) says deferred compensation under an eligible state/local plan is taxed only when actually paid or made available, and federal Treas. Reg. § 35.3405-1, A-23 makes clear that distributions from a state deferred-compensation plan are treated as wages - not pensions or annuities - for federal tax purposes (see also Rev. Rul. 82-46, 1982-1 CB 158). Because 1985 NY Laws ch. 306 (explained in TSB-M-85(16)I) conforms New York's tax treatment of these plans to the federal § 457 treatment, and Tax Law § 607 generally carries federal income characterization over into the state income tax, the same wage characterization applies for New York purposes too - "notwithstanding any characterization of them as such by Petitioner or by the company responsible for administering" the plan.

Once the payments are wages rather than pensions or annuities, § 612(c)(3-a) simply does not reach them. That provision's $20,000 exclusion is written narrowly: it covers only (1) pensions and annuities that are periodic payments for pre-retirement personal services arising from an employer-employee relationship or from federally-deductible retirement-plan contributions, and (2) distributions from IRAs under IRC § 408 or from self-employed/owner-employee plans qualifying under IRC § 401. Wages are not on that list. So Spaulding's deferred-comp distributions are included in both his federal adjusted gross income (via IRC § 457) and his New York adjusted gross income (via Tax Law § 612(a)), with no $20,000 exclusion available to offset them - regardless of the "annuity payment" terminology used along the way.

What this means for you

Retired state and local government employees with a Section 457 deferred-compensation plan

If you deferred salary into a state or local government § 457 plan and are now drawing it out in retirement, don't assume those payments get the same $20,000 pension exclusion that applies to a traditional employer pension. The Department treats § 457 deferred-comp distributions as wages for both federal and New York tax purposes, so they're fully includible in New York adjusted gross income with no age-based exclusion available under § 612(c)(3-a).

Retirees age 59 1/2 and older relying on the $20,000 pension exclusion

The § 612(c)(3-a) exclusion is limited to true pensions and annuities tied to pre-retirement personal services, plus IRA distributions and qualifying self-employed/owner-employee retirement plan distributions. If a label on your statement says "annuity" or "annuity payment," that label doesn't automatically qualify the income for the exclusion - check whether the underlying source is actually a pension/annuity arrangement, an IRA, or a § 401-qualified plan, as opposed to deferred wages paid out later under § 457.

Accountants and tax preparers confirming exclusion eligibility for clients

When a client's deferred-compensation statement uses annuity terminology, verify the type of plan generating the distribution before claiming the § 612(c)(3-a) exclusion. A state or local government § 457 plan produces wage income under federal Treas. Reg. § 35.3405-1, A-23, not pension or annuity income, and New York conforms to that federal characterization under Tax Law § 607 - so the exclusion is unavailable no matter how the distribution is described on paperwork.

Common questions

Q: My deferred-compensation plan statement calls my payment an "annuity payment" - does that mean I get the $20,000 pension exclusion?
A: No. The Department expressly held that distributions from the New York State Deferred Compensation Plan are wages for federal and state tax purposes "notwithstanding any characterization of them as such" by the taxpayer or the plan administrator. The label on the statement doesn't change the underlying tax character.

Q: Why are Section 457 deferred-comp distributions treated as wages instead of pensions?
A: Federal regulation § 35.3405-1, A-23 specifically treats distributions from a state deferred-compensation plan as wages, not pensions or annuities, for federal income tax purposes (see also Rev. Rul. 82-46, 1982-1 CB 158). Because 1985 NY Laws ch. 306 conforms New York's treatment of these plans to the federal § 457 treatment, and Tax Law § 607 generally follows the federal characterization of income, New York adopts the same wage characterization.

Q: What kinds of income actually qualify for the Tax Law § 612(c)(3-a) $20,000 exclusion?
A: Only two categories: (1) pensions and annuities that are periodic payments attributable to personal services performed before retirement, arising from an employer-employee relationship or from federally-deductible retirement plan contributions; and (2) distributions from IRAs under IRC § 408 or from self-employed/owner-employee retirement plans qualifying under IRC § 401. Wages - including § 457 deferred-comp payouts - are not included.

Q: Does it matter that Spaulding elected to spread his distributions over nine years instead of taking a lump sum?
A: No. The opinion doesn't turn on the payout schedule. Whether paid as a lump sum or spread over nine annual installments, § 457 deferred-comp distributions are taxed under IRC § 457(a) when paid or made available, and are characterized as wages either way - the installment structure doesn't convert them into an annuity for § 612(c)(3-a) purposes.

Q: Is any part of a Section 457 deferred-comp distribution ever eligible for the pension exclusion?
A: Not based on this opinion. Because the exclusion is defined by reference to specific categories (employer-employee pensions/annuities, IRAs, and § 401 self-employed plans) and § 457 distributions are categorized as wages rather than falling into any of those categories, none of the distribution qualifies for the § 612(c)(3-a) exclusion, regardless of amount or timing.

Citations and references

• Tax Law § 612(c)(3-a) - the $20,000 pension-and-annuity exclusion (age 59 1/2+), limited to employer-employee pensions/annuities, IRAs under IRC § 408, and self-employed/owner-employee plans under IRC § 401
• Tax Law § 607 - New York personal income tax generally conforms to the federal characterization of income
• Tax Law § 612(a) - amounts in federal adjusted gross income are included in New York adjusted gross income
• IRC § 457(a) - deferred compensation under an eligible state/local-government plan is includible in gross income only when actually paid or made available
• 1985 NY Laws ch. 306 - conforms New York's tax treatment of state deferred-compensation plan amounts to federal IRC § 457 treatment
• Technical Services Bureau Memorandum TSB-M-85(16)I - explains the Chapter 306 conformity amendment
• Treas. Reg. § 1.457-1(d)(3) - defines "amount(s) deferred" under an eligible plan as compensation deferred plus attributable income
• Federal Reg. § 35.3405-1, A-23 - treats state deferred-compensation plan distributions as wages, not pensions or annuities, for federal tax purposes
• Rev. Rul. 82-46, 1982-1 CB 158

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1988.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a88_4i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-88 (4) I
Income Tax
April 12, 1988

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I880318A

On March 18, 1988, a Petition for Advisory Opinion was received from Richard C.
Spaulding, 113 Murray Avenue, Delmar, New York 12054.
The issue raised is the applicability, for purposes of the personal income tax imposed under
Article 22 of the Tax Law, of the $20,000 pension and annuity exclusion under section 612(c)(3-a)
of the Tax Law to distributions received by a retired employee of New York State from the New
York State Deferred Compensation Plan.
Petitioner is sixty-one years of age and a retired employee of the State of New York. During
his employment with the State of New York, Petitioner opted to defer a portion of his salary pursuant
to the provisions of Internal Revenue Code section 457 which provides for "Deferred Compensation
Plans With Respect To Service For State And Local Governments." Upon retirement, Petitioner
opted to receive the distributions of his deferred compensation annually over a period of nine years
commencing on September 30, 1987. The company responsible for administering the New York
State Deferred Compensation Plan referred to Petitioner's first distribution payment as an "annuity
payment."
Internal Revenue Code section 457(a) provides that [i]n the case of a participant in a eligible
State deferred compensation plan, any amount of compensation deferred under the plan, and any
income attributable to the amounts so deferred, shall be includible in gross income only for the
taxable year in which such compensation or other income is paid or otherwise made available to the
participant or other beneficiary."
Chapter 306 of the Laws of 1985 amended the New York Tax Law to provide that amounts
deferred under State deferred compensation plans will receive the same treatment for New York
State personal income tax purposes as such amounts receive for federal income tax purposes under
section 457 of the Internal Revenue Code. Technical Services Bureau Memorandum TSB-M-85­
(16)I.
Federal regulation 1.457-1(d)(3) provides, in part: "Amounts deferred. 'Amount(s) deferred'
under an eligible plan means compensation deferred under the plan, plus income attributable to
compensation so deferred. Income attributable to compensation deferred under an eligible plan
includes gain from the disposition of property." 26 CFR 1.457-1.
In addition, Federal regulation 35.3405-1, A-23 makes clear that distributions from a state
deferred compensation plan are treated as wages for federal income tax purposes and do not qualify
as pensions or annuities. See also Rev.

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TSB-A-88 (4) I
Income Tax
April 12, 1988
Rul. 82-46, 1982-1 CB 158. Such distributions must also be characterized as wages for New York
State personal income tax purposes, as well. Tax Law section 607. Accordingly, such distributions
do not qualify as pensions or annuities for New York State personal income tax purposes
notwithstanding any characterization of them as such by Petitioner or by the company responsible
for administering the New York State Deferred Compensation Plan.
Section 612(c)(3-a) of the Tax Law provides a modification reducing federal adjusted gross
income in computing New York adjusted gross income for:
(3-a) Pensions and annuities received by an individual who has
attained the age of fifty-nine and one-half, not otherwise excluded
pursuant to paragraph three of this subsection, to the extent includible
in gross income for federal income tax purposes, but not in excess of
twenty thousand dollars, which 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 or (ii) from contributions to a retirement plan which are
deductible for federal income tax purposes.
Section 612(c)(3-a) also provides a modification for distributions from certain individual
retirement accounts or individual retirement annuities as defined in section 408 of the Internal
Revenue Code and from self employed individual and owner-employee retirement plans which
qualify under section 401 of the Internal Revenue Code.
Distributions from the New York State Deferred Compensation Plan are treated as wages for
federal and state income tax purposes. Therefore, they do not qualify as pensions or annuities and
do not qualify for the modification provided by Tax Law section 612(c)(3-a) which is expressly
limited in its application to pensions and annuities, IRA's and self-employed individual and owner­
employee retirement plans.
Accordingly, distributions from the New York State Deferred Compensation Plan are
included in Petitioner's federal adjusted gross income by operation of section 457 of the Internal
Revenue Code and are included in Petitioner's New York adjusted gross income by operation of
section 612(a) of the Tax Law.

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TSB-A-88 (4) I
Income Tax
April 12, 1988
Petitioner may not reduce his New York adjusted gross income by his distribution from the New
York Deferred Compensation Plan because such distribution is characterized for federal and state
income tax purposes as wages and wages do not qualify for the section 612(c)(3-a) modification.

DATED: April 12, 1988

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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