When an employer's bankruptcy forces a nonresident's exempt SERP annuity payments to be settled as a one-time lump sum, does the lump sum keep its New York tax-exempt character?

Plain-English summary

Deloitte & Touche LLP petitioned on behalf of a group of nonresident former executive officers of "Corporation A," a company headquartered in New York City. After retiring, these nonresidents received payments under non-qualified Supplemental Employee Retirement Plans ("SERP Arrangements") that Corporation A had set up to provide retirement benefits above what its regular qualified pension plans paid. Because those SERP payments met the New York regulatory definition of an "annuity" (paid only in money, at regular intervals, for life or a life-expectancy-based period, at a uniform or formula-based rate, under a written plan), they were exempt from New York personal income tax for these nonresidents under 20 NYCRR 132.4(d)(1)-(2) - nonresidents don't pay New York tax on annuity-type retirement income tied to their former New York service.

In September 1993, Corporation A filed for Chapter XI bankruptcy, which forced it to stop the SERP payments; the nonresidents became unsecured creditors along with the company's institutional lenders, trade vendors, and other unsecured claimants. A court-approved Plan of Reorganization, negotiated by a creditors' committee that did not include the nonresidents or their representatives, ultimately paid the whole class of unsecured creditors cash and securities worth about two-thirds of their claims' value, distributed on April 15, 1997. That meant the nonresidents' SERP claims - which had been paid out as periodic annuities - were instead settled with a one-time lump-sum payment.

The Department addressed two questions: whether the lump sum keeps the SERP payments' exempt "annuity" status despite becoming a one-time payment, and whether the SERP payments would separately have qualified as exempt "retirement income" under the federal Pension Source Tax Act (4 U.S.C. § 114(b)(1)(I)(ii), added by Public Law 104-95) for any payments after December 31, 1995, with that status likewise carrying over to the lump sum. Relying on Hort v. Commissioner (a settlement's tax character follows whatever it substitutes for - there, a lease-cancellation payment was taxed as the rent it replaced) and on a regulation treating a lump-sum death-benefit payout of an annuity-status pension as itself an annuity, the Department answered yes to both, conditioned on the underlying facts as described: assuming the pre-bankruptcy SERP payments truly qualified as annuities, and assuming the SERP arrangements were the type of deferred-compensation plan described in IRC § 3121(v)(2)(C), the lump-sum bankruptcy settlement is treated the same as what it replaced and remains untaxed by New York, because Corporation A's bankruptcy was an involuntary, unforeseen event forced by court order rather than something the nonresidents chose.

What this means for you

Nonresident executives with deferred comp facing an employer bankruptcy

If you were receiving exempt annuity-style retirement payments from a former New York employer and that employer's bankruptcy forces those payments to be replaced with a one-time settlement, this opinion supports treating the lump sum the same way the original payments were treated for New York tax purposes. The key is that the change happened involuntarily, through a bankruptcy court process, and not because you elected a lump sum instead of continued periodic payments.

Accountants and tax professionals tracking SERP and annuity taxation

When documenting a client's exempt annuity or retirement-income treatment, keep records showing that the pre-disruption payments met the full 20 NYCRR 132.4(d)(1)-(2) annuity test (money-only, regular intervals, life-contingent duration, uniform or formula-based rate, written instrument) and, for post-1995 amounts, that the arrangement fits the IRC § 3121(v)(2)(C) deferred-compensation definition referenced in 4 U.S.C. § 114(b)(1)(I)(ii). This opinion's holding is expressly conditioned on those facts being true ("assuming that... qualified as annuities"); it does not independently verify the SERP plan's design, so a later audit could still turn on whether that assumption actually holds.

Common questions

Q: Why did the Department treat a one-time lump sum the same as recurring annuity payments, when the regulation's own annuity test requires payments "at regular intervals, at least annually, for life"?
A: The Department reasoned by analogy to 20 NYCRR 132.4(d)(2)(v)(a), which already treats a lump-sum death-benefit payout of an annuity-status pension as itself an annuity, and to Hort v. Commissioner, which holds that a settlement payment takes on the tax character of the claim or item it replaces. Because Corporation A's bankruptcy - not the nonresidents' choice - forced the switch from periodic payments to a lump sum, the involuntary change didn't strip away the underlying annuity character.

Q: Would the outcome be different if the nonresidents had voluntarily chosen a lump-sum buyout instead of continuing annuity payments?
A: The opinion's reasoning turns specifically on the change being "unforeseen and involuntary," resulting from Corporation A's bankruptcy filing and the court-approved Plan of Reorganization rather than any election by the SERP participants. The opinion does not address a voluntary lump-sum election.

Q: Does this opinion independently confirm that the SERP Arrangements actually qualified as annuities?
A: No. The Department's conclusion is explicitly conditioned on "assuming that the Nonresidents' SERP payments received prior to Corporation A's bankruptcy filing qualified as annuities under section 132.4(d)(1) and (2) of the Regulations" - it accepts the petitioner's factual characterization rather than independently verifying the SERP plan documents.

Q: What is 4 U.S.C. § 114 and how does it interact with the state-law annuity analysis?
A: Section 114(a) of Title 4 of the U.S. Code, added by Public Law 104-95 and effective for amounts received after December 31, 1995, is a federal preemption provision barring any state from taxing the "retirement income" of a nonresident or nondomiciliary. Section 114(b)(1)(I) defines "retirement income" to include payments under a deferred-compensation arrangement described in IRC § 3121(v)(2)(C) that are either part of a series of substantially equal periodic payments or paid after termination of employment under a plan providing benefits in excess of certain qualified-plan limits. The Department concluded that if the SERP payments would have met that federal definition, New York couldn't tax them after 1995 regardless of the state annuity regulation, and the lump-sum settlement inherits that same federal exemption.

Q: Who was part of the "Class of Unsecured Creditors" alongside the SERP claimants, and does that matter to the ruling?
A: The class included the SERP claims together with claims from rejected executory contracts and the claims of Corporation A's institutional lenders, trade vendors, and suppliers, all of whom received the same roughly two-thirds-of-value cash-and-securities payout under the Plan. The opinion doesn't suggest that grouping changes the tax analysis - it simply reflects how the bankruptcy proceeding resolved all unsecured claims together, with the SERP claims retaining their own distinct tax character within that group settlement.

Q: Does Tax Law § 607(a) play a role in this opinion?
A: Yes, indirectly - it's cited for the general principle that terms used in Article 22 of the Tax Law take their meaning from the comparable federal Internal Revenue Code context unless a different meaning is clearly required, which supports the Department's reliance on federal authority (Hort and Rev. Rul. 76-171) to analyze the tax character of the settlement payment.

Citations and references

• 20 NYCRR 132.4(d)(1)-(2) (Personal Income Tax Regulations) - defines when a nonresident's pension or retirement benefit qualifies as a nontaxable "annuity"
• 20 NYCRR 132.4(d)(2)(v)(a) - a lump-sum death-benefit payment to a beneficiary of an annuity-status pension itself constitutes an annuity
• 4 U.S.C. § 114 (as added by Public Law 104-95) - bars states from taxing the "retirement income" of nonresidents/nondomiciliaries for amounts received after December 31, 1995
• Tax Law § 607(a) - terms in Article 22 follow the comparable meaning under the Internal Revenue Code absent a contrary intent
• Hort v. Commissioner, 313 U.S. 28 (1941) - a settlement or compromise payment takes on the tax character of the item it substitutes for
• Rev. Rul. 76-171, 1976-1 C.B. 18 - federal ruling taxing a lump-sum settlement of a non-qualified pension claim as ordinary income, citing Hort
• IRC § 3121(v)(2)(C) - defines the type of nonqualified deferred-compensation arrangement referenced in the federal "retirement income" definition

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1997.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a97_9i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-97(9)I
Income Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I970821A

On August 21, 1997, a Petition for Advisory Opinion was received from
Deloitte & Touche LLP, 2 World Financial Center, 8th Floor, New York, New York
10281-1426.
The issue raised by Petitioner, Deloitte & Touche LLP, is whether lump sum
settlements that nonresidents received from their non-qualified supplemental
employee retirement arrangements ("SERP Arrangements") claims are exempt from New
York State personal income tax because they qualify as either (1) annuities under
section 132.4(d)(1)and (2) of the Personal Income Tax Regulations ("Regulations")
or (2) "retirement income" as defined by section 114(b)(1)(I)(ii) of Title 4 of
the US Code, as added by Public Law 104-95.
Petitioner submits the following facts as the basis for this Advisory
Opinion.
Individuals
who
are
currently
nonresidents
of
New
York
State
("Nonresidents") were employed as executive officers of Corporation A at its
corporate headquarters in New York City.
Following their retirement, the
Nonresidents received payments pursuant to SERP Arrangements that were
established by Corporation A to provide retirement benefits greater than the
amounts payable under Corporation A's qualified pension plans.
In September 1993, Corporation A filed a petition requesting relief under
Chapter XI of the US Bankruptcy Code. As a result of the filing, Corporation A
ceased all SERP payments to the Nonresidents, and the Nonresidents became
unsecured creditors of Corporation A.
The Bankruptcy Court appointed a creditors' committee ("Creditors'
Committee") to represent all general unsecured creditors in negotiation with
Corporation A. Neither the Nonresidents nor their representatives were members
of the Creditors' Committee. Following lengthy and complex negotiations, a Plan
of Reorganization ("Plan") was agreed upon by the Creditors' Committee and
Corporation A and approved by a vote of the creditors of Corporation A.
Pursuant to the Plan, the Nonresidents' SERP claims were grouped within a
class that consisted of all the unsecured claims against Corporation A ("Class
of Unsecured Creditors"). In addition to the SERP claims, the Class of Unsecured
Creditors included claims in respect of the rejection of executory contracts, as
well as the claims of Corporation A's institutional lenders, trade vendors and
suppliers.

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Under the Plan, the Class of Unsecured Creditors received cash and
securities of Corporation A equal to approximately two-thirds of the value of
their claims. The cash and securities were paid out to the Class of Unsecured
Creditors on April 15, 1997, during the consummation of the Plan. As a result,
the Nonresidents' SERP payments, which previously were being paid out as
annuities, were settled as lump sum distributions.
Petitioner states that the SERP payments received by the Nonresidents prior
to Corporation A's bankruptcy qualified as annuities under section 132.4(d)(1)and
(2) of the Regulations, and, as such, were exempt from New York personal income
tax and withholding. Additionally, if the Nonresidents' SERP payments had not
been suspended as a result of Corporation A's bankruptcy, Petitioner states that
any payments received by the Nonresidents after December 31, 1995 would have been
exempt from New York personal income tax pursuant to section 114(b)(1)(I)(ii) of
Title 4 of the US Code, as added by Public Law 104-95.
Discussion
With respect to question "1", section 132.4(b) of the Regulations provides
that:
[t]he New York [source] income of a nonresident individual rendering
personal services as an employee includes the compensation for
personal services entering into [the individual's] Federal adjusted
gross income, but only if, and to the extent that, [the
individual's] services were rendered within New York State...
Section 132.4(d) of the Regulations provides the following:

Pensions or other retirement benefits constituting an annuity. (1)
General. Where an individual formerly employed in New York State is
retired from service and thereafter receives a pension or other
retirement benefit attributable to [the individual's] former
services, the pension or retirement benefit is not taxable for New
York State personal income tax purposes if the individual receiving
it is a nonresident and if it constitutes an annuity as defined in
paragraph (2) of this subdivision.
Where a pension or other
retirement benefit does not constitute an annuity, it is
compensation for personal services and, if the individual receiving
it is a nonresident, it is taxable for New York State personal
income tax purposes to the extent that the services were performed
in New York State....
(2) Definition.
To qualify as an annuity, a pension or other
retirement benefit must meet the following requirements:
(i) It must be paid in money only, not in securities of the
employer or other property.

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(ii) It must be payable at regular intervals, at least
annually, for the life of the individual receiving it, or over a
period not less than half of such individual's life expectancy as of
the date payments begin....
(iii) It must be payable:
(a) at a rate which remains uniform during such life or
period; or
(b) at a rate which varies only with:
(1) the fluctuation in the market value of the assets
from which such benefits are payable;
(2) the fluctuation in
recognized cost-of-living index; or

a

specified

and

generally

(3) the commencement of social security benefits; or
(c) in such a manner that the total of the amounts payable is
determinable at the annuity starting date either directly from the
terms of the contract or indirectly by the use of either mortality
tables or compound interest computation, or both, in conjunction
with such terms and in accordance with sound actuarial theory...
(iv) The individual's right to receive it must be evidenced by
a written instrument executed by [the individual's] employer, or by
a plan established and maintained by the employer in the form of a
definite written program communicated to [the employer's] employees.
(v) In the case of a pension or other similar benefit paid to
a nonresident beneficiary of a deceased employee:
(a) where the employee died after retirement, if the pension
or other retirement benefit [the individual] was receiving
constituted an annuity, payments to [the individual's] beneficiary,
even though they do not meet the requirements of subparagraphs (i),
(ii) and (iii) of this paragraph, will constitute an annuity ....
Section 607(a) of the Tax Law provides that any term used in Article 22 of
the Tax Law shall have the same meaning as when used in a comparable context in
the Internal Revenue Code, unless a different meaning is clearly required.
For federal income tax purposes, Rev Rul 76-171, 1976-1 CB 18, held that
a lump-sum payment received in settlement of a claim brought by the taxpayer
under a non-qualified, noncontributory pension plan was taxed as ordinary income.
The ruling cited Hort v Commissioner, 313 US 28 (1941), (85 L Ed 1168), in which
the Supreme Court of the United States held that in order to determine the nature
and extent to which settlement amounts received by compromise or judgement are
to be included in gross income, it is necessary to look to the nature of the item
that the settlement is a substitute for. In that case, the Court determined that

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the amount paid for cancellation of a lease was a substitute for rent that would
have been ordinary income to the recipient, and therefore, the settlement amount
was taxable as ordinary income.
In this case, Petitioner states that the Nonresidents' SERP payments
received prior to Corporation A's bankruptcy filing qualified as annuities under
section 132.4(d)(1)and (2) of the Regulations.
In this case, Corporation A's
bankruptcy prevented it from fulfilling the terms of its SERP contracts with the
Nonresidents. As a result of Corporation A's filing for bankruptcy under Chapter
XI of the US Bankruptcy Code, it ceased all SERP payments to the Nonresidents,
and the Nonresidents became unsecured creditors of Corporation A.
The
modifications to the Nonresidents' SERP payments were imposed by order of the US
Bankruptcy Court.
Under the Plan of Reorganization, the Nonresidents' SERP
payments, which previously were being paid out as annuities, were settled as lump
sum distributions.
Pursuant to section 132.4(d)(2)(v)(a) of the Regulations, where an
individual was receiving payments that constituted annuities under section
132.4(d)(2) of the Regulations, the death of the individual does not change the
taxability of future annuity payments even if the beneficiary receives a lump
sum payment for the remaining value of the annuity. Likewise, following Hort,
supra, to determine the nature of settlement amounts received by compromise or
judgement, it is necessary to look to the nature of the item that the settlement
is a substitute for. That is, the settlement amount received is treated the same
as the underlying item that was the basis for the settlement. In both of these
situations an involuntary act forces a change in the term of an annuity such that
it may no longer meet the requirements of section 132.4(d)(2) of the Regulations.
However, the lump sum payment or the settlement amount are treated the same as
the underlying annuity that was the basis of the lump sum payment or settlement
amount.
Similarly, Corporation A's unforeseen and involuntary act of filing for
bankruptcy under Chapter XI of the US Bankruptcy Code should not change the
treatment of the Nonresidents' SERP Arrangements as constituting nontaxable
annuities under section 132.4(d)(1) and (2) of the Regulations.
Accordingly, assuming that the Nonresidents' SERP payments received prior
to Corporation A's bankruptcy filing qualified as annuities under section
132.4(d)(1) and (2) of the Regulations, the lump sum payments received by the
Nonresidents pursuant to the Plan in settlement of the Nonresidents' SERP claims
against Corporation A will be treated as annuities under section 132.4(d)(1) and
(2) of the Regulations.
With respect to question "2", section 114(a) of Title 4 of the US Code, as
added by Public Law 104-95, applicable to amounts received after December 31,
1995, provides that "[n]o State may impose an income tax on any retirement income

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of an individual who is not a resident or domiciliary of such State (as
determined under the laws of such State)." Section 114(b)(1)(I) of Title 4 of
the US Code defines the term "retirement income" as any income from
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 ... 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.
Pursuant to section 114 of Title 4 of the US Code, New York State may not
impose personal income tax under Article 22 of the Tax Law on the retirement
income of a nonresident or nondomiciliary individual after December 31, 1995.
Following Hort, supra, to determine the nature of settlement amounts received by
compromise or judgement, it is necessary to look to the nature of the item that
the settlement is a substitute for. Therefore, for the reasons discussed in
question "1", a lump sum payment or settlement amount received in settlement of
payments that constituted retirement income under section 114 of the US Code
prior to a bankruptcy proceeding is treated the same as the underlying retirement
income that was the basis of the lump sum payment or settlement amount.
In this case, it is assumed that the Nonresidents' SERP Arrangements were
arrangements as described in section 3121(v)(2)(C) of the Code and that the
Nonresidents' SERP payments would have met the requirements of section
114(b)(1)(I)(ii) and would have constituted retirement income if Corporation A
had not commenced the bankruptcy proceeding. Accordingly, for New York State
personal income tax purposes, the lump sum payments received by the Nonresidents
pursuant to the Plan in settlement of the Nonresidents' SERP claims against
Corporation A will be treated as retirement income under section 114(b)(1)(I)(ii)
of the US Code.

DATED: October 28, 1997

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

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