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State Taxation of Compensation and Benefits (Portfolio 366)

Tax Management Portfolio, State Taxation of Compensation and Benefits, No. 366-2nd, focuses on the impact of state taxation on executive and employee compensation and benefits. A state's ability to assert jurisdiction to tax individuals who earn money in connection with the performance of services is based on the individual's domicile or residence in the state, or because the individual, although a nonresident, has earned money in the state through the performance of services attributed to the state.

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Tax Management Portfolio, State Taxation of Compensation and Benefits, No. 366-2nd, focuses on the impact of state taxation on executive and employee compensation and benefits. A state's ability to assert jurisdiction to tax individuals who earn money in connection with the performance of services is based on the individual's domicile or residence in the state, or because the individual, although a nonresident, has earned money in the state through the performance of services attributed to the state.

Federal law prohibits any state from imposing an income tax on “any retirement income” of an individual who is not a “resident” or “domiciliary” of the taxing state. The determination of an individual's residence or domicile for this purpose is made in accordance with the laws of the taxing state. Since state law rules permit more than one jurisdiction to treat an individual as resident, the possibility of multiple taxation remains. This is particularly true for individuals relocating at the time of their retirement. The application of this rule to nonqualified deferred compensation is fairly complex and, because the amounts of executive rewards can be substantial, can involve significant tax dollars.


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AUTHORS

RICHARD REICHLER
Richard Reichler is of Counsel with Meltzer, Lippe, Goldstein & Breitstone, LLP. His practice areas involve federal taxation, state taxation, executive compensation, employee benefits, financial restructuring, and real estate. Mr. Reichler has been a member of the adjunct faculty at Baruch College, the City University of New York and Hofstra University Law School.
Mr. Reichler was an Attorney Advisor, Office of the Chief Counsel, Internal Revenue Service in Washington, D.C. and Vice President, Tax Planning and Services and Deputy General Counsel, of the Long Island Lighting Company. He also acted as the National Director of Executive Compensation Planning while a Senior Tax Partner at Ernst & Young, P.C.'s New York office.
Mr. Reichler is a graduate of Columbia College and a graduate of Columbia University Law School. He is a member of the New York State Bar Association (Tax Section), and has been a member of the BNA Tax Management Advisory Board.

TABLE OF CONTENTS

Detailed Analysis

I. Background

A. Introduction

B. State Taxing Authority In General

1. Nexus

2. Residence/Domicile

3. Funding in Trusts

4. Allocation of Income

5. Federal Limitations

II. The State Income Tax Base – Conformity to Federal Base

A. General Rule

B. Other Conformity Issues

1. Joint Returns

2. Determination of Income

3. Determination of Tax Rate

C. Tax Credits

D. Exemptions

E. Itemized and Standard Deductions

III. Residence or Domicile

A. In General

B. State Definitions of “Resident”

1. In General

2. Domicile

3. New York Audit Guidelines

C. Changing to a Foreign Domicile

D. Statutory Nonresidents

E. Statutory Residents

F. Residence Controversies

G. Areas of Practitioner Concern

H. Relief from Multiple Taxation

1. In General

2. Constitutionality of Taxation of the Entire Income of a Statutory Resident

3. Taxation in the Case of a Change in Residence

4. Income Earned Before, But Received After a Change of Residence

5. Change of Residence and the Accrual of Income

6. Determination of Income Accruing In Connection with a Change in Residence

7. The Economic Benefit Doctrine

IV. State Law Considerations in Securing Deferred Compensation

A. In General

1. Contract Protections Used in Pay–As–You–Go Arrangements

2. Creditor Rights and Employer Security

a. Present Creditors

b. Potential Subsequent Creditors

c. Bankruptcy

3. Funding Deferred Obligations

a. Rabbi Trusts

b. Secular Trusts

B. Impact of State Law Priorities on Funded Plans

C. Foreign Trusts

D. ERISA Coverage and Funding

E. State Income Tax Treatment of Non–Qualified Trust Income

F. State Taxation of Undistributed Subchapter J Earnings

V. Source Taxation of Nonresidents

A. Allocation of Business Income Generally

B. Allocation of Employee Source Income

C. Employee v. Independent Contractor

D. Allocation of Nonresident Employee Source Compensation

E. Source Allocation Rules Applicable to Compensatory Payments

1. Deferred Compensation

2. Stock Options

3. Inconsistent Allocation Rules

4. Ballplayers and Artists – Special Rules

F. Income from Intangible Property Not Source Income

G. Deemed Intangibles

H. Intangible v. Source Income

I. Appreciation in Nonresident Compensatory Income – Intangible Income or Compensatory Income

1. Exposition of the Issue

2. Precedents with Respect to the Issue

VI. Source Issues with Respect to Other Compensatory Payments to Nonresidents

A. Bonus Payments

B. Severance Payments

C. Phantom Stock Plans

D. Non–Statutory Stock Options – What About the Bells and Whistles?

VII. Withholding and Special Accruals

VIII. Congressional Action Under the Commerce Clause

Introductory Material

A. Public Law No. 86-272

B. Public Law No. 104-95

1. In General

2. Committee Report

3. “Retirement Income” Described

4. Tax-Deferred Funding Vehicles Listed in Public Law No. 104-95

a. Qualified Plans Under I.R.C. 401(a) that are Exempt Under 501(a)

b. Simplified Employee Pensions Under I.R.C. 408(k)

c. Annuity Contract Plans Under I.R.C. 403(a)

d. Annuity Contract Plans Under I.R.C. 403(b)

e. Individual Retirement Plans Under I.R.C. 7701(a)(37)

f. Deferred Compensation Plans Under I.R.C. 457

g. Governmental Plans Under I.R.C. 414(d)

h. Trusts Under I.R.C. 501(c)(18)

i. I.R.C. 3121(v)(2) Payments

(1) In General

(2) Section 3121(v)(2)

(3) Stock Option Bells and Whistles

(4) Exclusion of Severance and Other Welfare Benefits

(5) When a Plan is Established

(6) Time and Rate of Payment

(7) Ratable Payment

(8) Excess Benefit Plans

5. Constitutionality of Pub. L. No. 104-95

IX. Interests in Limited Liability Companies and Partnerships

X. Constitutional Issues Relating to State Taxation

A. In General

B. Equal Protection

C. Privileges and Immunities

D. Due Process Clause

E. Commerce Clause

F. Taxes Discriminating Against the Federal Government

XI. Collection of Tax

A. In General

B. Minimum State Contacts to Establish a Withholding Obligation


WORKING PAPERS

Working Papers

TABLE OF WORKSHEETS

Worksheet 1 State of New York - Department of Taxation and Finance Income Tax - District Office Audit Manual Nonresident Allocation 5/4/98

Worksheet 2 [Reserved.]

Worksheet 3 Reserved

Worksheet 4 Pub. L. No. 104-95

Worksheet 5 H.R. No. 104-389 (Dec. 7, 1995) - Committee Report To Accompany Pub. L. No. 104-95

Worksheet 6 State Comparison Chart Taxation of Deferrals to 401(k) Plans

Worksheet 7 State-by-State Residency Requirements

Bibliography

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