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Richard Hyman

Non resident taxation of NQDC

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Non resident taxation of NQDC in New Jersey if residence is in Florida

under fed code 104-95, distributions  would not be taxed in the nonresident state if one of 2 conditions were met.

   The condition in question, is under section(ii) which state, if a plan was "created solely for the purpose of providing retirement benefits for employees in excess of the limitations imposed by 1 or more sections, including 401K plans".   How do you interpret "Soley"?   The plan I am questioning  states explicitly that the plan was created to allow tax savings for the participants. 

    I have submitted a non- resident tax  return,  requesting that all withheld NJ taxes   be returned. Will that be allowed?

 

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If a person can only participate if their compensation exceeds the 401(a)(17) limit, their total contributions exceed the 415 limit, if they must first contribute salary deferrals up to the 402(g) limit, or are otherwise limited by ADP testing, then I would say that constitutes "solely". If, however, anyone at or above a particular level/position, such as officers or other top management (i.e., a top-hat group), may participate and contribute without regard to the existence of any of the aforementioned limitations, then that would not constitute "solely".

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Could you give me some clarification of your reply, and if there is a specific place it describes the qualification of "soley".  So far, I have seen only professional interpretations, not legal definitions. 

     In this specific plan, the employee is only put into the plan, without option, when their income level is over the "highly compensated" limit  this year at $125,000.  If the income goes below this level,  they are returned to the 401k type plan.  In the  NQDC plan in this case, there is a formula for a yearly bonus(making up for the lost company matching of the 401k plan), however, they are  NOT required to contribute to the plan to receive this bonus. The maximum contribution for highly compensated employees,  is 25%, while specific upper management levels can defer 100% of their income. How does that fit into your qualification of soley?  How does the non-resident state qualify if the plan is soley?   Will they possibly audit the return, to see if it meets their test of solely?   

   

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Not much legal guidance has been provided other than what was discussed in Congress at the time the bill was being debated.  The following is from the House Report that accompanies the passage of 104-95:

 (I) Any plan, program, or arrangement described in section 3121(v)(2)(C) of the Code, provided such income is part of a series of substantially equal periodic payments made for the life or life expectancy of the recipient (or for the joint lives or joint life expectancies of the recipient and the designated beneficiary of the recipient) or for a period of not less than 10 years. Payments under such an instrument may not occur less frequently than annually.
    The periodic payment rule established by subparagraph (I) shall not apply to a plan, program, or arrangement which would, but for sections 401(a)(17) and 415 of the Code, be described in subparagraph A.
    The effect of subparagraph (I) would be to exclude from State taxation certain amounts of income paid under non-qualified deferred compensation arrangements, that is, plans which are not recognized as ``qualified'' under the tax code. These are unlimited, flexible arrangements without contribution limits, funding requirements, or limits on payout provisions. The availability and use of such arrangements is limited to a small proportion of the work force. Payments made by employers
to non-qualified plans are includable in the employee's income in the year in which made, regardless of whether the employee has a right to distribution. Employers often do not fund non- qualified plans, therefore, until they are ready to make actual distributions to the recipients.
    Subparagraph (I) also protects from State taxation ``excess benefit'' plans that are set up because a qualified plan in a particular instance (1) would exceed the $150,000 ceiling in annual employee compensation that employers may take into account in determining contributions made to or benefits paid from a qualified plan (section 401(a)(17)); or (2) would exceed the present limits on the amount of allowable benefits from a defined benefit plan or the present limits on the amount of allowable contributions to a defined contribution plan (section 415). Defined benefit plans give employees a special benefit at retirement, commonly based on a percentage of the employee's compensation and number of years of service to the employer. The employer will annually contribute an amount that is
actually required to fund the benefit at retirement. Defined contribution plans specify the amount of contribution that is to be made annually. This exemption applies without regard to whether the periodic payment requirements of subparagraph (I) are met.

Looking at these explanations of the terms, it is clear that you would like your plan to be considered an "excess benefit" plan to take advantage of the exemption.  The plan sponsor should confirm whether the plan was designed to be treated as such; based on the description provided, it does not seem to be.  The plan sponsor needs to get this right as well as they have the obligation to deduct and remit withholding to the appropriate taxing authority. 

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For completeness - bold paragraph is what is being discussed

4 U.S. Code § 114 - Limitation on State income taxation of certain pension income

(a)   No State may impose an income tax on any retirement income of an individual who is not a resident or domiciliary of such State (as determined under the laws of such State).

(b)  For purposes of this section—

(1)  The term “retirement income” means any income from—

(A)   a qualified trust under section 401(a) of the Internal Revenue Code of 1986 that is exempt under section 501(a) from taxation;

(B)   a simplified employee pension as defined in section 408(k) of such Code;

(C)   an annuity plan described in section 403(a) of such Code;

(D)   an annuity contract described in section 403(b) of such Code;

(E)   an individual retirement plan described in section 7701(a)(37) of such Code;

(F)   an eligible deferred compensation plan (as defined in section 457 of such Code);

(G)   a governmental plan (as defined in section 414(d) of such Code);

(H)   a trust described in section 501(c)(18) of such Code; or

(I)  any plan, program, or arrangement described in section 3121(v)(2)(C) of such Code (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), if such income—

(i)  is part of a series of substantially equal periodic payments (not less frequently than annually which may include income described in subparagraphs (A) through (H)) made for—

(I)   the life or life expectancy of the recipient (or the joint lives or joint life expectancies of the recipient and the designated beneficiary of the recipient), or

(II)   a period of not less than 10 years, 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.

The fact that payments may be adjusted from time to time pursuant to such plan, program, or arrangement to limit total disbursements under a predetermined formula, or to provide cost of living or similar adjustments, will not cause the periodic payments provided under such plan, program, or arrangement to fail the “substantially equal periodic payments” test.

Such term includes any retired or retainer pay of a member or former member of a uniform service computed under chapter 71 of title 10, United States Code.

(2)   The term “income tax” has the meaning given such term by section 110(c).

(3)   The term “State” includes any political subdivision of a State, the District of Columbia, and the possessions of the United States.

(4)   For purposes of this section, the term “retired partner” is an individual who is described as a partner in section 7701(a)(2) of the Internal Revenue Code of 1986 and who is retired under such individual’s partnership agreement.

(e)  Nothing in this section shall be construed as having any effect on the application of section 514 of the Employee Retirement Income Security Act of 1974.

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