FYI - EGTRRA and California State Taxes

[Christine Roberts]

Here is the result of some research I recently did on the topic - I welcome all comments/criticism.

"Counting EGTRRA Before It’s Hatched:

California Legislators Struggle to Bring State Tax Laws Into Conformity

With New Federal Deduction Limits

In June of last year, Congress passed sweeping legislative changes affecting retirement plans, known as “EGTRRA” (short for the Economic Growth and Tax Relief Reconciliation Act of 2001). Among other significant changes, EGTRRA (a) increased contribution limits (and corresponding deductions under federal income taxes) under IRAs (including Roth IRAs, traditional IRAs, and Education IRAs), (B) increased contribution and deduction limits under qualified retirement plans (including salary deferral limits under Section 401(k), 403(B), and 457 plans), introduced a “catch-up” deferral for individuals aged 50 or older, and increased rollover options among IRAs and qualified plans. Most EGTRRA changes are effective for plan years beginning on or after January 1, 2002.

Many of you may have already approved modifications to your retirement plan documents conforming to EGTRRA’s new provisions. Employees who participate in such plans, or who maintain IRAs, have warmly welcomed the increased opportunities for retirement savings under EGTRRA.

However, in California and approximately a dozen other states, state income tax laws do not automatically conform to federal standards. As a consequence, employees in these states who participate in retirement arrangements to the maximum extent now permitted under federal law could face state income tax liability on contributions that exceed state tax levels. Conceivably, an employee’s entire retirement savings could be subject to state taxation under such circumstances, but it is unlikely that state taxing authorities would adopt so drastic an approach.

A recent article in the Los Angeles Times (January 6, 2002 Business Section) summarized this dilemma and mentioned three pieces of conforming legislation now before the California legislature. The applicable bills are SB 657, sponsored by Senator Jack Scott (D-Pasadena), AB 1744, sponsored by Assembly Member Ellen M. Corbett (D-San Leandro), and AB 1743, sponsored by Assembly Member John Campbell (D-Irvine).

Although there are distinctions among the bills, each essentially seeks to conform California’s Revenue and Taxation Code to the new contribution and deduction limits available to both individuals and businesses under EGTRRA (Note: AB 1744 would not allow deductions under state taxes for increased contributions to Education IRAs).

Of the three pieces of legislation, Assembly Bills 1743 and 1744 were only just introduced on January 7, 2002, while SB 657 has already been amended and is currently before the Committee on Revenue and Taxation, slated for hearing on January 9, 2002. According to a consultant to the Committee who is assisting Senator Scott on the Bill, it is widely acknowledged in Sacramento that passage of conforming legislation must occur sometime during 2002. That said, the consultant would not acknowledge that passage this year is a “done deal, “ because conforming the state tax laws will cost the state between $40 to $50 million dollars during a year when difficult budget issues are already looming on the horizon. Although the consultant stated that passage of conforming legislation is possible sometime in January or February of 2002, delays are possible in the event the matter gets caught up in the budget approval process. If conforming legislation is not finalized until next year, it is possible that the legislation would allow the filing of amended returns or other tax reporting that would permit employees to catch-up, for state tax purposes, with their federal deferral limits.

How does this sum up, for purposes of employee communications? It is safe to say that it is likely that California will enact legislation later this year, to conform to EGTRRA. In the meantime, an employee has two options: (a) defer up to the maximum federal limits in anticipation of timely changes to state law, with the potential of exceeding state income tax deduction limits if state law changes are delayed; and (B) under-defer, for federal purposes, until such time as state law catches up to the EGTRRA standard. In this latter instance, it is possible the employee will miss out on maximum federal deductions if conforming legislation does not pass until 2003, and takes effect on a prospective basis only.

For those of you who are interested in tracking the progress of the various Senate and Assembly Bills, contact information for the Senator Scott, and for Assembly Members Corbett and Campbell can be found at http://democrats.assembly.ca.gov/english/index.htm."

© Christine P. Roberts, Esq. 2002

[Kirk Maldonado]

Thank you for sharing this valuable information with us.

[Harwood]

What is the 401(k) limit in California in 2002? Due to cost-of-living adjustments, it surely would've risen to $11,000. But with the EGTRRA non-conformity - and the IRS not posting a COLA adjustment - is California stuck at $10,500?

[MGB]

The IRS only posted the adjusted numbers in an Information Release; it did not require their action. The Code itself defines what the new numbers each year are and no action by the IRS is needed (although the rounding of percentage adjustments to a certain number of decimal places came from procedures established by the IRS through their Information Releases).

The Cal. (and numerous other states) statutes refer to the Internal Revenue Code as it stood at a particular pre-EGTRRA date (e.g., 1/1/1999). The Code at that time stated how to calculate inflation-adjusted figures into the future. Therefore, the numbers are still around, and yes, the 2002 402(g) limit would be $11,000 without EGTRRA (they will start to diverge next year unless inflation picks up dramatically).

[david rigby]

Thanks to MGB for his usual lucid explanations. One item to add though is the catch-up contribution. If the plan is amended to permit catch-ups, that would not be covered in the reference in the state statute for 2002.

This could be a nightmare in the following manner: the tax basis for federal purposes would differ from the tax basis for state purposes, and could differ by state. Anybody's recordkeeping system track that?

[Guest Jeff Hartmann]

I checked the CA legislation web site and unfortunately, Assembly bills 1743 and 1744 don't go into Committee hearing until February 7.

Fortunately, though, Senate Bill 657 had a hearing yesterday.

[Christine Roberts]

Thanks for the update, Jeff. The consultant on SB 657 who I reached mentioned that a fix is possible sometime in January or February...let's hope.

[Guest gerry326]

Pax asked about tracking the taxability difference between state and federal for catch up contributions. This is a function of your payroll system, so you should check with your provider - they have to set up a separate dedection for the catch ups anyway.

Anyone running a payroll with Pennsylvania workers is already doing this because PA does not recognize 401(k) contributions as deferred from state tax.

[imchipbrown]

I understand the catch-up contribution discussion, but have not seen any opinions about whether the profit-sharing deduction limit (15% or 25%), annual addition limit (25% or 100%), and compensation limits ($170k, 180K? or $200k) are equally a problem here in California.

Any thoughts?

[Guest Jeff Hartmann]

Originally posted by MGB

The Code at that time stated how to calculate inflation-adjusted figures into the future.  Therefore, the numbers are still around, and yes, the 2002 402(g) limit would be $11,000 without EGTRRA .

Agreed. Does anyone know whether California's estimate of $ 44 million revenue loss for 2002 may be mistakenly including some cost for 401k limit rising to $ 11,000 ?

[imchipbrown]

Can anyone add some insight to my query above?

Thanks

Chip Brown

[Harwood]

I think it is clear that no EGTRRA provisions are currently in effect for California tax purposes.

For example: The California Public Employees' Retirement System 457 plan will not implement the new rollover provisions of EGTRRA for fear of jeopardizing the plan and/or creating taxable income for the Participant.

See: http://www.calpers.ca.gov/benefits/defcomp...p/457taxlaw.htm

[Harwood]

402(g)(5) says that "The Secretary shall adjust the $7,000 amount under paragraph (1) at the same time and in the same manner as under section 415(d) . . ."

415(d)(1) states "The Secretary shall adjust annually . . ."

1.415-5(a)(1) has "the annual adjustment factor is to be determined by the Commissioner . . "

Since the Secretary did not adjust the $7,000 for COLA (due to EGTRRA 2001), I think that states using the old Internal Revenue Code are stuck at a 401(k) limit of $10,500 for 2002.

[Guest Jeff Hartmann]

I disagree with your conclusion. I think it could be argued either way.

Just because the Secretary didn't announce an adjustment under 415(d), there is still a method specified under 415(d)(2) and (3). The IRS announcement in December 2001 did include information that the adjustment factor (to be applied to unrounded limits, before the final step of rounding) was 1.0270 for 2002, so that the 415(d) methodology could be continued as needed (such as in this case).

So, in the absence of states incorporating the new language under EGTRRA, they would follow the old language, including the method for performing the adjustment ..... which results in an adjustment to $11,000 for 2002.

[MGB]

To all interested:

The IRS has informally stated that they may provide a release that gives the numbers under the pre-EGTRRA rules. In addition to states needing this there are also plans that are not amended for EGTRRA (particularly union plans that won't amend until the end of the current cycle) and need the numbers.

Jeff,

Be careful about the calculation. It is not just an increase from year to year.

The 1.0270 that was included in the release is for adjusting the section 415 100% of compensation limit after retirement, which is a year-by-year adjustment.

The adjustment for the 402(g) limit (and every other limit) is a calculation of the ratio of the CPI (the average of the three CPIs in the third quarter) in the year before the adjustment divided by the same CPI average in the "base year." Every limit has its own base year depending on when the provision was put into the law. This one is 1987. The ratio is then multiplied by $7,000.

Whether you do the actual calculation using the base year or the year-by-year calculation, you would almost always get the same result after the final rounding (they may not match if the result were very close to the rounding figure). The unrounded amount will be off slightly because the CPI calculation and the ratio detmination only uses a few digits.

The unrounded amount for 2002 (using the proper base period calculation) is $11,268.

Applying 1.027 to $10,973 from 2001 would produce $11,270; doing the year by year all the way from the beginning (assuming you never knew the intermediate figures and just kept your own running total of the unrounded amount) would produce $11,266.

[Guest Jeff Hartmann]

Originally posted by MGB

Be careful about the calculation.  It is not just an increase from year to year.

Thanks for mentioning this (although I already know this).

I quoted the "1.0270 for 2002" adjustment mainly to support my theory that the Secretary "has adjusted" the prior limits for purposes of those plans (and those states) that still operate under pre-EGTRRA rules.

I maintain my own "database" of CPI figures, including the base figure of 331.2 for 4th quarter 1986 (although IRS limits seem to be based upon 331.3, when I look at pre-1995 limits which were not rounded down), and 533.3 for 3rd quarter 2001. Using the 331.3 base, I agree with your $11,268 unrounded amount for 2002.

[david rigby]

Thanks MGB for the unrounded amounts. Of course, all of those amounts will round to $11,000, which is the point.

[imchipbrown]

You guys are good!

Put your pencils to this -

Does the 415© limit go from 35k to 40k by itself?

Where does the $170K comp limit go by itself?

I'm sure I'm not the only one who's curious.

Chip

[Guest Jeff Hartmann]

Originally posted by Chip Brown

Does the 415© limit go from 35k to 40k by itself?

Not even close ..... the unrounded is approx. $36,585

The pre-EGTRRA comp. limit increases from 170K to $180,000 for 2002 (unrounded $182,925).

Both are computed by adjusting the 1994 limits ($30,000 and $150,000) by the ratio 1.2195 (533.3 divided by 437.3 base for 4th qtr 1993).

[MGB]

How soon we forget...

There is another reason for keeping track of the old numbers. There is that little issue called a SUNSET provision in 2010.

As we move further into deficits instead of surpluses, it is going to be very difficult to get every EGTRRA provision extended.

[Harwood]

The California Employment Development Department tells employers who ask to use $10,500 for the 401(k) limit for purposes of California Income Tax withholding and reporting in 2002.