A client lived in IN until 03/01/05 and worked in Louisville, KY. Client moved to FL on 03/01/05 after leaving KY employer under a termination agreement and was paid wages until 12/31/05. Employer deducted KY taxes and Louisville taxes on severance wages paid. In addition, the client was paid a large deferred compensation amount in July. What's the best way to allocate the wages and deferred compensation between the two states? IN has a much lower tax rate than KY. I'm mostly concerned about the deferred compensation since most of it was deferred while an IN resident. I'd sure appreciate any help or suggestions. KY withholding was in excess of $15,000.
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Help
Gosh, everyone must be busy. I sure could use some help with this question. -
Dont' know
I don't know the answer but sure hope someone will jump in.
My gut feeling is that if the deferred payment is not the same as a pension, some sort of retirement, than it would be taxable in KY. What exactly was the deferred payment for?Comment
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deferred comp
was the deferred comp a life insurance contract set up as a supplemental retirement plan for highly compensated employees? if so, i would tax the wages to the state of residency at the time the compensation was paid, which is FL and you most likely are aware of the lack of an income tax in FL. this question is perplexing to say the least and may require some digging.Comment
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More info on deferred comp issue
Thanks for the replies. The deferred compensation represented both employer and employee matching contributions to a nonqualified deferred compensaton plan during employment. The client was a resident of IN working in KY. IN and KY are reciprocal states for withholding. The employee contributions were made via a salary reduction each pay period during the period of employment.
The client was employed on July 1, 2002 and terminated employment on October 18, 2004. The separation agreement provided for severance pay including all benefits and participation in all programs as if employed until July 17, 2005. At that time, the deferred compensation was also paid. The client was a reisident of IN until March 1, 2005 and moved to Florida. At that time, the employer began withholding KY taxes. KY taxes all income earned in their state. I believe both severance pay and deferred compensaton are defined as "earned income" by KY.
As such, the question is was the deferred income "earned" when the contributions were made? As such, is it possible to allocate the deferred income between IN and KY? Or, is the income "earned" when the payout is made? I suspect all of it is taxable in KY, but I sure wish I could find an argument why it shouldn't be.Comment
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Nonqualified deferred compensation
KY treats nonqualified deferred compensation and severance pay as "wages" based on IRC Section 3401(a).
Under the federal rules, nonqualified deferred compensation generally becomes taxable when it is paid, not when the contributions are made.
I think the only way you could allocate the income to Indiana was if the client retained a domicile in Indiana at the time the payments were made.Comment
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Nancy - Sadly, I think you're correct. In this case, the taxpayer was penalized heavily by moving to a no tax state. The difference is state tax is about $8,000.Comment
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???
I don't quite understand the difference in pension pay, if qualified plan or non-qualified plan. I thought ALL pension payments are taxable only to the residence state, which would be Florida. What am I missing?Comment
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Years ago, states like California wanted to tax pensions that came about from people who worked in California. I had a couple of ladies who had been retired from the phone company for over 10 years living in Minnesota when California started sending them bills wanting them to pay California tax as a nonresident, since their pensions came from a job they each had in California years ago.
Then the federal government finally stepped in and said states cannot tax qualified pension distributions unless the recipient is a resident of the state. However, I believe that law only applies to qualified pension plans. I do not believe non-qualified deferred compensation plans were included in that law, leaving the states free to decide for themselves whether non-qualified distributions are taxable or not. A state could thus claim that non-qualified deferred comp is the same as earning a W-2 wage from that state.Last edited by Bees Knees; 01-28-2006, 03:50 PM.Comment
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Nonqualified Def comp also may be subject to local tax
It doesn't always stop with state taxes. There are some cities and townships that also consider a distribution from a nonqualified plan "earned income" for tax purposes.Comment
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Original Thread
Again, the original thread was about compensation, and the discussion has morphed into pensions (although also a very informative subject and comment from Bees Knees).
As with ALL state taxation, the question is which state can claim that their state is the "source" of income. This is not a pension, as most of us think of deferred compensation as a 401k or similar arrangement. Being not a pension, but rather a rear-ended payment arrangement by his employer, this income is reduced to W-2 salaries and wages, unless I have misunderstood something.
Kentucky wins, big-time. Louisville was the source of the income. Even if Florida had an income tax, the best that could be claimed would be a credit against Florida taxes for the amount the taxpayer had to pay Kentucky for the income received as a FL resident.Comment
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