Information Release

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.
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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.
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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

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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.