Maryland State tax withholding mandatory as of 7/1/05?

[Guest Julie Woulfe]

I have a Maryland Bankers Association Bulletin that refers to Chapter 444, House Bill 147 of the 2005 Session of the Maryland General Assembly, which requires payouts of eligible rollover distributions from qualified retirement plans to withhold Maryland tax whenever federal tax is withheld....effective 7/1/05. I have found this Bill on the internet, and this is indeed what it seems to say.

However, I contacted John Hancock (formerly Manulife) where we have many Plans that are participant directed, and they claim that their compliance area says mandatory Maryland State withholding is not yet effective, and they will not be changing their distribution forms until it is effective.

Does anyone know whether this is effective 7/1/05?

[mbozek]

Why do you think the distributions are subject to mandatory state tax withholding since ERISA prempts all state laws. How can MD enforce mandatory w'holding against out of state plans or plans that use a non MD trustee? Ins co that do business in states that have withholding laws prefer to withhold state tax to keep the state ins. regulators happy but I dont think the plan has any obligation to withhold st. income tax from a qualified plan distribution any more than plan assets can be turned over under state escheat laws.

[E as in ERISA]

Lots of states already apply mandatory withholding to residents http://www.prudential.com/media/managed/2005SWIS-CB.pdf

Won't Maryland just move from the "tell us" to the "we will withhold" box?

[mbozek]

Requiring mandatory withholding of state income tax is different for being able to enforce such a requirement against an ERISA plan, especially a plan that has no presence in the state. If Plan X is administered in NY and uses a NY bank as trustee, how would MD enforce its withholding requirement against plan X for a pension distributions sent to a MD resident? Anyway State witholding laws are preempted under ERISA.

[E as in ERISA]

Instead of arguing state preemption, I think that most large administrators just follow the rules.

In response to Julie's question, the state's web site says effective July 1 http://taxpros.marylandtaxes.com/

[david rigby]

Let's be careful about apples and oranges. The link to the Maryland provisions, provided just above, discusses distributions eligible for rollover.

"Eligible Rollover Distributions. TG §10-908 has also been amended to require a payor to withhold from a payment to a resident payee that is an eligible rollover distribution within the meaning of §3405© of the Internal Revenue Code and is subject to mandatory withholding of federal income tax, Maryland income tax equal to the sum of 3 percent and the top marginal state income tax rate for individuals under TG §10-105(a), which is currently 4.75 percent.

This provision of the Act will take effect July 1, 2005."

Thus, it is not referring to monthly pension payments. The Prudential link includes discussion about both types of payments.

But the practical issue for the recipient is to make sure the state does not include a tax penalty for underwithholding. Thus, most plans will do as "E" has suggested. Mbozek may be correct about pre-emption, but no plan and no individual wants to go to court for that purpose.

[mbozek]

I dont see how this issue could ever wind up in ct since there is precedent in the 8th circuit that state tax levies cannot be enforced against an ERISA pension plan. Second I do not know how a state tax authority can enforce mandatory withholding provisions against a plan that has no presence in the state other than by suing the plan administrator in the state where the plan is administrated. Would MD go to the trouble of suing a NY pension plan in NY to enforce a MD tax law? The participant can avoid penalities for underwithholding by making a voluntary payment of estimated state taxes.

Many plan administrators will not comply with state withholding rules because of the administrative burden of complying with different rules for each state and the charges that will be imposed by the trustee or other payors to make such payments. The preemption provision of ERISA was intended to prevent plans from having to comply with multiple inconsistent state laws affecting benefits.

[Belgarath]

This subject interested me, so I did a brief web search for information. I found several entries from different states that were substantially similar to the following:

TIR 97-2

Income Tax

Massachusetts Tax Treatment of Certain Pension Income

--------------------------------------------------------------------------------

This Technical Information Release (TIR) explains the Massachusetts income tax treatment of certain pension or retirement income following enactment of Public Law 104-95 (P.L. 104-95). This law prevents any state from taxing income from certain pensions and deferred compensation plans paid to individuals who are not residents or domiciliaries of that state. Massachusetts already exempts much of the pension income paid to non-residents covered by P.L. 104-95, but will, in accordance with it, now exempt from taxation some previously taxable pension income.

Discussion

Public Law 104-95 amends Title 4 of the United States Code to include new Section 114. This section prevents a state from taxing pension income received after December 31, 1995 by persons who are neither residents nor domiciliaries of that state if the income is received from:

(1) a qualified trust under IRC § 401(a) exempt from taxation under IRC § 501(a);

(2) simplified IRC § 408(k) plans;

(3) IRC § 403(a) annuity plans;

(4) IRC § 403(b) annuity contracts;

(5) IRC § 7701(a)(37) individual retirement plans;

(6) eligible deferred compensation plans of state and local governments and tax exempt organizations as defined by § IRC 457;

(7) IRC § 414(d) government plans;

(8) a trust or trusts described in IRC § 501©(18); and

(9) any plan, program or arrangement described in IRC § 3121(v)(2)© if payments are made at least annually and spread over the actuarial life expectancy of the beneficiaries, or if payments are spread over at least a ten year period. Such income is also protected from state taxation if the plans are trusts under IRC § 401(a), but exceed limits laid down in IRC §§ 401(k), 401(m), 402(g), 403(b), 408(k) or 415 or any other limitation on contributions or benefits which may apply in the Code.

P.L. 94-105 also prevents taxation of any retirement or retainer pay of a non-resident or a non-domiciliary member or former member of a uniformed service computed under Chapter 71 of Title 10 of the United States Code (military pensions).

Much of the income from pensions listed above was already exempt from Massachusetts taxation when the income was received by a non-resident. See 830 CMR 62.5A.1(5), exempting, in general, non-resident pension income from qualified plans. The principal new exemptions affecting Massachusetts taxation relate to income from:

(1) non-contributory government plans;

(2) eligible deferred compensation (IRC § 457) plans;

(3) IRC § 501©(18) plans;

(4) non-qualified plans under IRC § 3121; and

(5) military pensions of non-residents.

This TIR applies to amounts received after December 31, 1995. Nothing in this TIR affects the taxation of pension income received by residents or domiciliaries of Massachusetts.

Mitchell Adams

Commissioner of Revenue

January 31, 1997

As to whether ERISA prempts any state law regarding mandatory state withholding for a resident in a situation where distribution isn't being rolled and federal 20% withholding is required, I have no opinion, although it does seem odd to me that so many states would impose this requirement if it is in fact unenforceable. However, I agree with previous comments that most PA's/payors would just do it. And it doesn't sound like Hancock thinks otherwise - only that they believe it doesn't apply yet.

[mbozek]

There are a lot of unenforceable state and federal laws (e.g., gift tax which is dependent on the taxpayer voluntarily notifying the govt that an unreported gift has occurred. Also who pays state use tax on out of state purchases.) I dont think Hancock believes that state tax must be withheld from ERISA plans but will comply with the law because insurance co are regulated by 50 states for compliance with state laws and is set up to do state tax withholding. Many banks and other trustees do not have the systems capability to withhold state taxes from multiple states, just as many employers do not withhold state income taxes of employees who live in states where the employer does not have a business presence, e.g. NY employer with no presence in NJ wont withhold NJ income tax from employee's wages.

[Guest Harry O]

I'm not sure that ERISA preempts "all state laws" or all state tax laws in particular. Is there some authority for this statement? A court case? I seem to recall authority to the contrary. But I could be wrong.

My recollection is that withholding is usually imposed as a matter of law on the plan administrator. If the plan administrator is the employer (which, for better or worse, is very common) and the employer conducts business in the state, I would think that the state can enforce its withholding rules against the employer. I'm not sure it matters that the trustee is a financial institution or other organization that doesn't do business in the state.

[mbozek]

Mandatory withholding of state taxes from distributions is an alienation of pension benefits which is permitted only for fed taxes because ERISA does not preempt other federal laws. There is no exemption from preemption for withholding of state taxes from distributions. It doesnt matter whether the employer conducts business in the state. The fact that some payors (Insurers) will process state tax withholding of pension distributions does not mean that the plan is required to allow such withholding.

[Guest Harry O]

Is this your opinion or is there caselaw to this effect?

[mbozek]

See Northwest airlines v. Roemer , 603 F Supp 7 (1984) where fed ct held that st tax levy on retirement benfits was preempted by ERISA.

[E as in ERISA]

This is not a levy against benefits -- it is withholding on the distribution -- and the state law specifically references the ERISA plan.

[mbozek]

You are missing the point- both a levy for taxes and withholding of a portion of a distribution for state taxes by the plan are an alienation of a participant's benefits under state law which is prohibited by ERISA. I am not saying that plans cannot allow for voluntary withholding of state income tax by participants but that it cannot be mandated that a plan must withhold state income tax. ERISA was designed to prevent states from imposing administrative burdens on plans under conflicting state laws. A participant could bring a claim against a plan that reduces his benefit to comply with state law.

The solution is for residents to pay estimated state taxes instead of witholding.

[E as in ERISA]

I understand the point. But there are some on this board who would probably not actually read that case. And I don't want them to think that the holding in Northwest Airline v. Roemer specifically says that state withholding laws are preempted by ERISA. I believe it says that a state law providing for levy of taxes (a law that doesn't specifically mention levies against retirement plans) is preempted by ERISA. And there are some that would say that case is effectively overturned by Mackey v. Lanier, in which the US Supreme Court said that a state garnishment law (used against a welfare plan) was not preempted by ERISA.

Now I'm not saying that your conclusion about pre-emption is wrong. Just that Northwest Airlines v. Roemer is not on all fours here. I'm not sure we know for certain what the Supreme Court would say. The boundaries of the preemption are a little fuzzy. (Many would say that ERISA preempts state wage withholding laws -- but all the automatic enrollment bills include a specific ERISA preemption just to make it 100% certain).

[Belgarath]

Mbozek - accepting for the moment that your assertion is correct (and I have no opinion one way or the other), I'm curious as to the next step where a participant could bring a claim against the plan.

So, what could a participant get from the plan? Can they get punitive damages of some form, or only "equitable" settlement, whatever that means? I have a layman's impression that in an ERISA suit you can generally get, to paraphrase, what you would have gotten in the first place. Plus maybe attorney's fees?

If so, this seems to put the PA between a rock and a hard place, and I'd be interested in your opinion as to which is the better or less risky approach. The PA can refuse to withhold, and risk a fight with state authorities (even though PA will ultimately win if your ERISA premption argument is upheld/accepted) or the PA can risk a suit/complaint by the participant.

So who do you choose to irritate? And if you potentially have a fight on your hands, which fight can cost you the most as a PA?

Thanks!

[Demosthenes]

I'd have to agree with Belgarath, even if you're right, the pain is going to outweigh the gain.

States can't place a tax lien on qualified assets. States can't tax or demand withholding for non-residents. States can and do demand withholding on qualified plan distributions made to residents.

As a practical argument, I am not aware of a firm with a national reach that does not do withholding in the mandatory states of IA, KS, MA, ME, OK & VT (and potentially MD). Nor am I aware of a regional firm that does not at least do withholding for mandatory states within their footprint.

So technically you may be correct, but as someone once said "God fights on the side of the heaviest artillery" and the States seem to have the big guns.

[mbozek]

I am not saying that the state tax cannot be withheld but that a plan that distributes benefits to participants in another state that requires withholding does not have to go to the trouble of establishing withholding procedures to satisfy a state tax law. There are many small and mid sized plans whose payor systems do not have the capability to withhold state tax in multiple jurisdictions and should not be required to do so. If the plan wants to offer state tax withholding thats fine but some of the withholding rates are far in excess of the amount of state tax due on the distribution.

E- Mackey is not precedent because it applied to welfare plans which are not subject to the non alienation requirement and cannot be disqualfied for paying over benefits to a state taxing authority. In Egeroff the Supreme Ct held that state laws affecting distributions of benefits under an ERISA plan are preempted.

As far as the reach of a state to enforce withholding against a non resident plan, I have never heard of a state issuing an order to a non resident plan administrator to withhold state taxes since there is no way to enforce such an order. I dont see any risk in not complying.

Participants can bring nusience claims against a plan, and then file nuisance suits. There are tax protestors like the employee in the Northwest case who relish defying the govt by objecting to taxes.

[E as in ERISA]

Egelhoff? A life insurance case involving a state law saying that beneficiary designations are voided upon divorce. Determined to be pre-empted but specifically saying it doesn't violate any anti-alienation rules....

[mbozek]

Egelhoff involved pension benefits as well as LI and the state law was preempted because it interfered with nationally uniform plan administration, e.g. plans cant be subject to different state laws regarding payment of death benefits, which is no different than subjecting plans to different rules for st. income tax withholding.

From the majority decison "Uniformity is impossible however, if plans are subject to different legal obligations in different states."

[Guest TAG]

Mbozek,

Were you aware tha PA taxes deferrals on 401k plans on the way in? States can do whatever they wish. And that includes assessing penalties for failure to withhold correctly. Case law is great for discussion, but little use to the average administrator.

Mandatory tax withholding states are:

Delaware, Iowa, Kansas, Massachusetts, Maine, North Carolina, Oklahoma, Virginia

and Vermont. Now Maryland.

Withholding if subject to 10% early penalty - Mississippi

Withholding unless elected out - California and Oregon.

While we are on the subject, check out each States' withholding transmission requirements- mind blowing. I oversee almost a million distributions a year to every country, state, territory and commonwealth. Each one is different and each one has laws which are to be followed. Do the right thing or do things right...the eternal question.

TAG, CPA, APM, QKA

[mbozek]

And NJ taxes salary reduction to 403(b) plans, 457 plans and 125 plans but not 401k plans. However, ERISA does not preempt state taxation of wages paid to employees and withheld by the employer doing business in the state, which is different from state tax withholding of benefits paid by the plan which is a separate legal entity where state laws are preempted. States are not free to do what they wish regarding distribution of benefits from an ERISA plan, because, as the Supreme ct has noted, this would prevent national uniformity in the administration of plans. Your statement as to the complex requirements for complying with each state/local laws is precisely the rationale adopted by the Sup. ct. in Egelhoff for preempting state laws because of the administrative burdens imposed on the plan.

I dont know any way a state could enforce withholding laws or penalty provisions against a plan that is not located in the state, since the plan is not subject to that state's laws, as well as ERISA preemption of state tax laws. You should consider reducing state withholding burdens on benefit distributions by applying federal laws.