IT 1996-01 -- Personal Income Tax: Federal Law Preempting
State Taxation of Retirement Plan Income - Issued March 11,
1996; Revised May 2007
The purpose of this information release is to address federal
law preempting state income taxation of certain types of
retirement plan income. Endnotes are indicated by
italics, and are annotated at the bottom of the
release.
This federal legislation was enacted in 1996
and amended in 2006 by
public law 109-264.(1)
This legislation prohibits a state from imposing an income
tax on "retirement income" of an individual who is neither a
resident of nor a domiciliary of such state, as determined
under the laws of such state at the time the income is
received.
For purposes of this law, "retirement income" means income
from any of the following:
- Governmental retirement system plans, "qualified"
retirement plans,(2) and
- All other deferred compensation plans and "nonqualified"
retirement plans(3) if such
deferred compensation plan income or such “nonqualified”
retirement plan income . . .
1. . . . is paid in a series of substantially equal
periodic payments (not less frequently than annually) for
the life or life expectancy of the recipient or the joint
lives or joint life expectancy of the recipient and the
recipient's beneficiary or
2. . . . is paid in a series of substantially equal
periodic payments (not less frequently than annually) for a
period of not less than ten years or
3. . . . is a payment after termination of the recipient’s
employment and is made 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 (i) the limitations imposed by one or more
sections 401(a)(17), 401(k), 401(m), 402(g), 403(b),
408(k), or 415 of such Code or (ii) any other limitation on
contributions or benefits in such code on plans to which
any of such sections apply.
Based upon this federal law, the numerator of the fraction
used to calculate the Ohio nonresident income tax credit will
include such income when such income is received by a
nonresident of Ohio. Furthermore, based upon both this
legislation and departmental policy, the following
withholding tax guidelines are now applicable with respect to
distributions from retirement plans:
Distributions from Ohio's state retirement
funds (such as the Ohio Public Employees
Retirement System): the administrator of the retirement
plan shall withhold Ohio individual income tax from such
distributions to nonresidents of Ohio only if the recipient
so requests.
Distributions from other governmental retirement
plans or from private sector "qualified" retirement
plans: the administrator of the plan is required
to withhold Ohio individual income tax from such
distributions only if all four of the
following apply:
1. The payor is an employer;
2. The payor maintains an office or transacts business
within Ohio;
3. The payor is making payment of compensation to an
employee;(4)
and
4. The employee resides in Ohio at the time of the payment
of that compensation.
Only if all
four of the above tests are met will Ohio individual
income tax withholding be required with respect to
distributions from such plans. Since most retirement
plan recipients are no longer employees of the company from
whom they receive pension benefits, in most situations Ohio
does not require withholding from such plans described
above.
Distributions from all other deferred compensation
plans and "nonqualified" retirement plans: Ohio individual
income tax withholding is required only if all five of the
following are present:
1. The payor is an employer;
2. The payor maintains an office or transacts business
within Ohio;
3. The payor is making payments of compensation to an
employee;
4. The employee either (i) worked in Ohio for the payor at
the time the employee earned the right to receive such
income from the payor or (ii) is residing in Ohio or is
domiciled in Ohio at the time s/he receives the payment;
and
5. The recipient is either a resident of Ohio at the time
of the receipt of the payment, or, if the recipient is not
a resident of Ohio at the time of the receipt of the
payment, then . . .
. . . the payment does not represent one
of several payments which are substantially equal, periodic
payments or
. . . if the payment does represent one of several payments
which are substantially equal, periodic payments, such
payments either (i) are not made for the life
expectancy of the recipient (or the joint lives or joint
life expectancy of the recipient and the recipient's
designated beneficiary) or (ii) are made for a period of
less than ten years.
Only if all
five of the above tests are met will Ohio individual
income tax withholding be required with respect to
distributions from plans other than government
retirement plans and private sector qualified retirement
plans.
____________________________________
Observations:
1. Except for individuals participating in "nonqualified"
deferred compensation programs, in most situations most
individuals receiving retirement plan payment are no longer
employees of the organization. Thus, in most cases payments
of retirement benefit from government-sponsored retirement
system plans and from "qualified" retirement plans will not
be subject to Ohio income tax withholding.
A plan is generally a "nonqualified" plan if the plan
discriminates in favor of highly-compensated executives. Such
plans can include deferred bonus programs which allow the
recipient to receive her/his bonus over several years. In
most cases the payor will be the employer (rather than a
separate pension plan trust), and the payment will be subject
to federal income tax withholding and will be reported on IRS
form W-2. In those situations where such payments are
reported on the IRS form W-2, such payments to nonresidents
will be subject to Ohio individual income tax withholding
only if the five above-listed requirements are present.
Because deferred bonuses are a form of a nonqualified
deferred compensation program, we require income tax
withholding with respect to payment of such deferred bonuses
to nonresidents if all five of the above-listed requirements
are present.
2. Now that the U. S. Congress has specifically addressed
retirement income attributable to retirement plans, the
Department of Taxation's position is that nonresidents who
exercise stock options received on account of employment in
Ohio must pay Ohio individual income tax on the Ohio-related
appreciation. For purposes of determining the Ohio-related
appreciation, the nonresident will treat as Ohio income the
value of the unexercised stock option at the time the
individual left Ohio minus the value of the unexercised stock
option at the time the individual received the option. In
those cases where an individual receives a stock option prior
to either moving to or working in Ohio, then the Ohio-related
appreciation will be based upon the value of the unexercised
stock option when the individual leaves Ohio minus the value
of the unexercised stock option at the time the individual
first became a resident of Ohio or first began working in
Ohio.
____________________________________
For more information about this law, you can send us an
e-mail by clicking on “Contact Us” on the left hand side of
our home page then sending us an e-mail. You can also call us
at the numbers listed below:
1-614-466-5285
Ohio Relay Service for the hearing-impaired:
1-800-750-0750
____________________________________
Endnotes:
(1) This legislation, among other things, amended
section 114(b)(1)(I) of title 4, United States Code by
inserting “(or any plan, program, or arrangement that is in
writing, that provides for retirement payments in recognition
of prior service to be made to a retired partner, and that is
in effect immediately before retirement begins)” after
“section 3121(v)(2)(C) of such Code”. Because the Ohio
Department of Taxation’s policy has been to treat such income
as being sitused to the recipient’s state of domicile (which
is what the amendment now mandates), this amendment will not
affect any individual’s calculation of Ohio income tax.
(2) A “qualified” plan is one that meets the
requirements of Internal Revenue Code Section 401(a) and is
thus eligible for favorable income tax treatment.
(3) A “nonqualified” retirement plan is one not
meeting the requirements of Internal Revenue Code Section
401(a).
(4) Based upon the first paragraph of Ohio Revised
Code section 5747.01 (“. . . any term used in this chapter
that is not otherwise defined in this section has the same
meaning as when used in a comparable context in the laws of
the United States relating to federal income taxes . . .”),
the Ohio Department of Taxation treats an individual as an
"employee" for Ohio withholding tax purposes if the Internal
Revenue Service treats the individual as an employee for
federal withholding tax purposes.