New York Advisory Opinion TSB-A-94(1)I: Are distributions from the federal Thrift Savings Plan (TSP) that petitioner Joseph T. DiGianni receives exempt from New York State income tax; if not, is the first $20,000 tax-free whether taken as a monthly annuity or a lump sum; and if the distributions are taxable, is the portion of earnings from the TSP's 'G Fund' (invested in U.S. government bonds) tax-free as tax-exempt interest?

Subject

Whether distributions from the Federal Employees' Thrift Savings Plan (TSP) received by petitioner Joseph T. DiGianni are tax free at the New York State level; if not, whether the first $20,000 received is tax free whether taken as a monthly annuity or as a single lump sum payment; and if the TSP distributions are taxable, whether the earnings derived from the "G Fund" (U.S. Bonds) are tax free.

Plain-English summary

Joseph T. DiGianni asked the Department to explain how New York taxes distributions from the federal Thrift Savings Plan (TSP), the retirement savings and investment plan Congress created for federal employees in the Federal Employees' Retirement System Act of 1986. He raised three questions: (1) are TSP distributions entirely tax-free in New York; (2) if not, is the first $20,000 tax-free whether paid as a monthly annuity or a lump sum; and (3) if taxable, is the part of TSP earnings that came from the "G Fund" — a fund invested in U.S. government bonds — tax-free as interest income.

The answer turns on which federal retirement system the employee belongs to. Employees hired on or after January 1, 1984 are generally under FERS, which combines Social Security, a defined-benefit "basic annuity," and the TSP itself as the defined-contribution piece; FERS employees get automatic 1%-of-pay agency contributions plus up to a 4% agency match, on top of their own voluntary contributions of up to 10% of pay. Employees hired before that date are generally under CSRS, a stand-alone defined-benefit annuity plan; a CSRS employee gets no agency TSP contribution but may elect under 5 U.S.C. § 8351 to voluntarily contribute up to 5% of basic pay to a TSP account purely as a supplement to the CSRS annuity. Contributions and earnings in a TSP account are tax-deferred until withdrawn, and under IRC § 7701(j) the account is treated as a tax-exempt trust under IRC §§ 401(a) and 501(a).

Because the TSP is itself the defined-contribution half of a FERS employee's pension, the Department held that a FERS employee's TSP distributions are part of that employee's pension and qualify for New York's full pension exclusion under Tax Law § 612(c)(3), which excludes pensions paid to officers and employees of the United States to the extent includible in federal gross income (a rule that exists in part to satisfy the constitutional rule of Davis v. Michigan Dep't of Treasury, 489 U.S. 803 (1989), that a state cannot tax federal retirement benefits more heavily than its own). A CSRS employee's TSP account, by contrast, is only a voluntary supplement to the CSRS annuity rather than the pension itself, so it does not qualify for the § 612(c)(3) full exclusion.

That does not leave CSRS TSP distributions fully taxable, though. They can instead qualify for the separate $20,000 pension-and-annuity income exclusion under Tax Law § 612(c)(3-a) and 20 NYCRR 112.3(c)(2), available whether the distribution is taken as periodic annuity-style payments or as a lump sum, provided the taxpayer is at least 59 1/2 and the other conditions of that section are met. Finally, on the "G Fund" question, the Department held the interest earned on the underlying U.S. government bonds does not stay tax-exempt once it is distributed: under IRC § 402(a)(1) and § 72, a qualified trust's distributions are taxed in full as annuity income with no distinction between contributions and earnings, so the "G Fund" interest loses its character as interest and becomes ordinary annuity income. Because Tax Law § 607 ties Article 22's terms to their federal meanings, no separate New York interest-income modification is available for it under Tax Law § 612(c)(1) either.

What this means for you

FERS and CSRS federal retirees living in or moving through New York planning TSP withdrawals

Which system you're under changes your New York tax result. If you're a FERS retiree, your TSP withdrawals are treated as part of your pension and are fully excludable from New York income under Tax Law § 612(c)(3), the same as your basic annuity. If you're a CSRS retiree, your TSP withdrawals don't get that full exclusion because the TSP was only ever a voluntary supplement to your CSRS annuity — but you can still exclude up to $20,000 of those distributions under Tax Law § 612(c)(3-a) once you're 59 1/2, whether you take the money as monthly payments or a lump sum. Either way, don't expect any special break for the part of your account invested in the "G Fund"; once it comes out of the TSP, that U.S. bond interest is just ordinary annuity income for New York purposes.

Accountants reconciling federal-vs-NY pension exclusions for TSP distributions

When a client's TSP distribution shows up on a federal return, the first thing to check is whether the client was FERS or CSRS, since that decides whether Tax Law § 612(c)(3)'s full pension exclusion or Tax Law § 612(c)(3-a)'s capped $20,000 exclusion applies. For a CSRS client relying on § 612(c)(3-a), confirm the age-59 1/2 and other 20 NYCRR 112.3(c)(2) conditions are satisfied, and note that the regulation allows both periodic and lump-sum IRA/Keogh-type distributions to qualify for that modification (though a Keogh lump sum using the federal 10-year-averaging method is carved out — a fact pattern this opinion didn't need to reach). Don't try to carve out a client's "G Fund" earnings as tax-exempt municipal or government bond interest; under IRC § 72 that interest character is lost the moment it is distributed from the trust, and Tax Law § 607 imports that federal result directly into Article 22.

Common questions

Q: Why does it matter whether DiGianni (or any TSP participant) is a FERS or CSRS employee?
A: Under FERS, the TSP is the defined-contribution component of the pension itself, so its distributions are part of "the pension" and qualify for the full exclusion under Tax Law § 612(c)(3). Under CSRS, the core pension is a separate defined-benefit annuity, and the TSP is only a voluntary supplement an employee elected to fund under 5 U.S.C. § 8351 — so a CSRS employee's TSP distributions are not "the pension" and don't get that same full exclusion.

Q: If a CSRS employee's TSP distributions aren't fully excludable, are they fully taxable in New York instead?
A: Not necessarily. They can still qualify for the separate $20,000 pension-and-annuity exclusion under Tax Law § 612(c)(3-a) and 20 NYCRR 112.3(c)(2), as long as the distribution is included in federal adjusted gross income, is attributable to personal services performed before retirement through an employer-employee relationship or tax-deductible retirement contributions, and the individual is at least 59 1/2.

Q: Does it matter whether the $20,000 exclusion is taken as monthly payments or a single lump sum?
A: No. 20 NYCRR 112.3(c)(2) specifically allows IRA and Keogh-type account distributions to qualify for the $20,000 modification whether they are periodic payments or a lump sum, so a CSRS employee's TSP withdrawal can qualify either way, provided the other conditions of Tax Law § 612(c)(3-a) are met.

Q: The TSP's "G Fund" is invested in U.S. government bonds. Why isn't that interest tax-exempt when it's paid out?
A: Under IRC § 402(a)(1) and § 72, everything a qualified trust like the TSP distributes is taxed as annuity income, with no distinction drawn between principal and earnings. That means the "G Fund" interest loses its identity as "interest" once it passes through the TSP and is distributed — it becomes ordinary annuity income. Because Tax Law § 607 gives Article 22 terms their federal meaning, New York follows that same result and allows no separate interest-income modification under Tax Law § 612(c)(1).

Q: Why does New York exclude federal pensions from tax at all?
A: The U.S. Supreme Court held in Davis v. Michigan Dep't of Treasury, 489 U.S. 803 (1989), that a state cannot tax federal retirement benefits at a higher rate than it taxes its own state and local retirement benefits. Tax Law § 612(c)(3)'s exclusion for pensions paid to U.S. government officers and employees exists to keep New York's tax treatment of federal pensions on par with its treatment of state pensions, consistent with that constitutional requirement.

Citations and references

• Tax Law § 612(c)(3) - modification excluding pensions paid to officers and employees of the United States, to the extent includible in federal gross income
• Tax Law § 612(c)(3-a) - $20,000 pension and annuity income exclusion for taxpayers age 59 1/2 or older whose pensions aren't otherwise excluded under § 612(c)(3)
• Tax Law § 612(c)(1) - interest income modification (held inapplicable to TSP "G Fund" earnings once distributed)
• Tax Law § 607 - Article 22 terms take their meaning from comparable federal income tax law
• 20 NYCRR 112.3(c)(2) - conditions for the pension and annuity income modification, including that IRA/Keogh-type distributions qualify whether periodic or lump sum
• IRC § 7701(j) - the Thrift Savings Fund is treated as a tax-exempt trust described in IRC §§ 401(a) and 501(a)
• IRC § 402(a)(1) - amounts distributed by a qualified employees' trust are taxable to the distributee under IRC § 72
• IRC § 72 - taxation of amounts received as an annuity, with no distinction between contributions and earnings
• Davis v. Michigan Dep't of Treasury, 489 U.S. 803 (1989) - a state cannot tax federal retirement benefits at a higher rate than its own state retirement benefits

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1994.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a94_1i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-94 (1) I
Income Tax
January 21, 1994

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I930823G

On August 23, 1993, a Petition for Advisory Opinion was received from
Joseph T. DiGianni, 40 Robert Circle, Syosset, New York 11791.
The issues raised by Petitioner, Joseph T. DiGianni, are:
(1) Whether distributions from the Federal Employees' Thrift Savings Plan
(TSP) are tax free at the New York State level.
(2) If not tax free, whether the first $20,000 received is tax free
whether taken as a monthly annuity or as a single lump sum payment.
(3) If the TSP distributions are taxable, whether the earnings derived
from the "G Fund" (U.S. Bonds) are tax free.
The TSP is a retirement savings and investment plan for Federal employees.
The TSP was established in the Federal Employees' Retirement System Act of 1986.
Employees covered by the Federal Employees' Retirement System (hereinafter
"FERS") and the Civil Service Retirement System (hereinafter "CSRS") can
contribute to the TSP. The participation rules are different for FERS and CSRS
employees. FERS employees are generally those hired on or after January 1, 1984.
CSRS employees are those hired before January 1, 1984.
The provisions of the FERS, which consists of a combination of social
security, a defined benefit plan and a defined contribution plan are contained
in Chapter 84 of Title 5 of the United States Code (hereinafter "USC"). The
defined benefit plan is the "basic annuity" and the defined contribution plan is
the TSP and is established by Subchapter III of such Chapter 84.
The provisions of the CSRS, which is a defined benefit plan, are contained
in Chapter 83 of Title 5 of the USC. The defined benefit plan is an annuity. In
addition, section 8351 of such Chapter 83 provides that an employee covered by
the CSRS may elect to contribute to the TSP established by section 8437 of Title
5 of the USC. By making such election, an employee may supplement his/her CSRS
annuity.
The FERS basic annuity and the CSRS annuity benefits are based on an
employee's years of service and salary, and contributions to these programs are
mandatory payroll deductions.
The TSP benefits depend on how much an employee and the employee's agency
contribute to the employee's account during working years, and the earnings on
such contributions. Where an employee is covered by CSRS, such employee does not
receive any agency contributions. However, if an employee covered by CSRS makes
TP-9 (9/88)

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the election contained in section 8351 of Title 5 of the USC, such employee may
make voluntary contributions to his/her TSP account of up to five percent of the
employee's basic pay each pay period not to exceed IRC limits.
Where an employee is covered by FERS, under Chapter 84 of Title 5 of the
USC such employee is entitled to receive two different types of contributions to
such employee's TSP account from the employee's agency. These contributions are
not payroll deductions. When the employee becomes eligible to participate in the
TSP the employee's agency will open a TSP account and each pay period the
employee's agency will automatically contribute to the account an amount equal
to one percent of the employee's basic pay for that period. The employee receives
these contributions whether or not the employee contributes his/her own money to
his/her TSP account.
If the employee does contribute his/her own money to
his/her TSP account, the employee's agency makes agency matching contributions
to the employee's TSP account up to four percent.
These agency matching
contributions apply to the first five percent of employee's pay each pay period
that the employee contributes. This is in addition to the agency automatic
contribution of one percent. An employee's contributions to his/her TSP account
are voluntary and the employee may contribute up to 10 percent of his/her basic
pay each pay period not to exceed Internal Revenue Code limits.
Employee contributions into his/her TSP account and the earnings on the
account are tax-deferred until the funds are withdrawn. An employee cannot
withdraw from his/her TSP account while still employed by the Federal government.
If the employee is covered by FERS and has not met the TSP vesting requirements
when the employee separates from Federal service, the employee is not entitled
to the agency automatic one percent contributions in the employee's TSP account
(or their earnings). However, employees covered by FERS are always vested in the
matching contributions their agencies make, as well as in the earnings on the
matching contributions.
In addition, employees covered by FERS as well as
employees covered by CSRS are always vested in their own contributions and the
earnings on such contributions.
Withdrawals may be made from an employee's TSP account after the employee
separates from Federal service. When the employee separates from Federal service
and the employee's vested TSP account balance is $3,500, or less, such balance
will be paid to the employee automatically in a single payment called an
"automatic cashout" unless the employee chooses another withdrawal option. If
the employee is not eligible for retirement benefits under his/her FERS or CSRS
when the employee separates, and the employee does not qualify for the automatic
cashout, the employee must transfer the vested account balance to an IRA or other
eligible retirement plan (a tax-qualified employee benefit plan, an IRA, an
individual retirement annuity, or an annuity plan described in section 403(a) of
the Internal Revenue Code). If the employee is eligible for retirement benefits
when the employee separates from Federal service, the employee may receive the
balance of the employee's TSP account as an automatic cashout, if qualified, or
the employee may transfer the account balance to an IRA or other eligible
retirement plan, receive the account balance in a single payment, receive the
account balance in substantially equal monthly payments or receive a life annuity
based on the balance in the account.

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Section 7701(j) of the IRC provides that for income tax purposes, the
Federal Thrift Savings Fund shall be treated as a trust described in section
401(a) of the IRC which is exempt from taxation under section 501(a) of the IRC,
and any contribution to, or distribution from the Thrift Savings Fund shall be
treated in the same manner as contributions from such a trust.
Section 35.3405-1,A-18 of the Treasury Regulations provides that the
withholding provisions relating to pensions and annuities do not apply to any
amounts that are wages without regard to the provisions of section 3405 of the
Treasury Regulations. However, wages do not include remuneration paid to, or on
behalf of, an employee or beneficiary from or to a trust qualified under section
401(a) of the IRC and tax-exempt under section 501(a) of the IRC.
The United States Supreme Court in Davis v Michigan Department of Treasury,
489 US 803 (1989), held that the state taxation of Federal retirement benefits
at a greater rate than the taxation of state retirement benefits is
unconstitutional.
Section 612(c)(3) of the Tax Law provides for a modification reducing
Federal adjusted gross income for "pensions to officers and employees of the
United States of America ... to the extent includible in gross income for federal
income tax purposes."
Section 612(c)(3-a) of the Tax Law provides For a modification reducing
Federal adjusted gross income for pensions and annuities received by an
individual who has attained the age of 59 1/2, not otherwise excluded pursuant
to section 612(c)(3), to the extent includible in gross income for Federal income
tax purposes, but not in excess of $20,000, which are periodic payments
attributable to personal services performed by such individual prior to his or
her 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. However, the term "pensions and annuities" does
not include any lump sum distribution, as defined in section 402(e)(4)(A) of the
Internal Revenue Code (hereinafter "IRC") and taxed under section 603 of the Tax
Law.
Section 112.3(c)(2) of the Income Tax Regulations provides that:
(i) For taxable years beginning on or after January 1, 1982, pension
and annuity income, not in excess of $20,000, received by an
individual not subject to the modification allowed under paragraph
(1) of this subdivision, may be subtracted in computing New York
adjusted gross income providing the following conditions are met:
(a) the pension and annuity income must be included in Federal
adjusted gross income;
(b) the pension and annuity income must be received in
periodic payments (except where otherwise provided in this
paragraph);

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(c) the pension and annuity income must be attributable to
personal services performed by such individual,
prior to such
individual's retirement from employment, which arises from either an
employer-employee relationship or from contributions to a retirement
plan which are tax deductible under the Internal Revenue Code (e.g.,
individual retirement account lIRA]
or self-employed retirement
[Keogh]); and
(d) such individual receiving the pension and annuity income
must be 59 1/2 years of age or over.
(ii) Distributions from an individual retirement account (IRA) or a
self-employed retirement plan (Keogh) will qualify for the pension
and annuity income modification whether such distributions are
periodic payments or a lump sum distribution. However, a
modification will not be allowed under this paragraph for a lump sum
distribution from a self-employed retirement plan (Keogh) if the
Federal special 10-year averaging method of determining the Federal
income tax due on such lump sum distribution is elected (see section
601-c of the Tax Law for provisions relating to determining the New
York State separate tax on the ordinary income portion of a lump sum
distribution where the special 10-year averaging method has been
elected for Federal income tax purposes).
Herein, with respect to Issue "1", where an employee is covered by FERS,
the distributions received by such individual from such employee's TSP account
are considered part of such individual's pension and may be allowed as a
deduction from Federal adjusted gross income, pursuant to section 612(c)(3) of
the Tax Law, to the extent includible in gross income for Federal income tax
purposes.
Where an employee is covered by CSRS, the distributions received by such
individual from such employee's TSP account are considered as a supplement to
such individual's pension and such distributions not allowed as a deduction from
Federal adjusted gross income, pursuant to section 612(c)(3) of the Tax Law.
However, with respect to Issue "2", such distributions are treated as a
retirement benefit, and are not considered wages for purposes of the IRC pursuant
to section 35.3405-1,A-18 of Treasury Regulations. Therefore, such distributions
may be allowable as a deduction, pursuant to section 612(c)(3-a) of the Tax Law,
to the extent such distribution is includible in gross income for Federal income
tax purposes, if the individual meets all of the requirements contained in such
section 612(c)(3-a) and section 112.3(c)(2) of the Income Tax Regulations.
With respect to Issue "3", section 402(a)(1) of the IRC provides that the
amount actually distributed to any distributee by any employees' trust described
in section 401(a) of the IRC which is exempt from tax under section 501(a) of the
IRC shall be taxable to the distributee, in the taxable year of the distributee
in which distributed, under section 72 (relating to annuities) of the IRC.
Section 72(a) of the IRC provides that, except as otherwise provided in the
income tax provisions of the IRC, gross income includes any amount received as
an annuity under an annuity, endowment or life insurance contract. Accordingly,
when a taxpayer receives a distribution from an employee's TSP account, no
distinction is made between contributions and earnings. Where the contributions
into the employees TSP account are invested in the "G Fund" (a U.S. Bond Fund)
the interest earned on such investment loses its character as interest income and

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is treated as annuity income under section 72 of the IRC.
Section 607 of the Tax Law provides that terms used in Article 22 are to
be given the same meaning "as when used in a comparable context in the laws of
the United States relating to federal income taxes, unless a different meaning
is clearly required." Thus, the IRC's exclusion of the income in question from
the category of "interest" means that is not to be treated as interest for
purposes of Article 22 of the Tax Law, and no modification is allowed under
section 612(c)(1) of the Tax Law.

DATED: January 21, 1994

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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