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New federal law restricts state taxation of nonresidents' pensions.

On Jan. 10, 1996, President Clinton signed H.R. 394 into law, greatly restricting states, such as California, from imposing a "source" tax on retirement income of former residents. (See News Notes, "State and Local Taxes," TTA, Feb. 1996, p. 68.) California's Franchise Tax Board indicated that it had been collecting approximately $25 million annually from retired former residents, which was only a fraction of what the state suspects it should have collected.

This new law, effective Jan. 1, 1996, precludes source taxation of distributions from qualified retirement and annuity plans, simplified employee pensions, tax-sheltered annuity contracts, individual retirement accounts, deferred compensation plans of state and local governments and tax-exempt organizations (under Sec. 457), governmental plans (under Sec. 414(d)) and pre-June 25, 1959 pension trusts (under Sec. 501 (c) (18)).

It also precludes source taxation of distributions from nonqualified deferred compensation plans if those distributions are part of a series of substantially equal periodic payments (not less frequently than annually) made for:

* The life or life expectancy of the recipient (or the joint lives or joint life expectancies of the recipient and the recipient's designated beneficiary); or

* A period of not less than 10 years.

This treatment also applies to payments received after termination of employment under a "mirror plan" that is a nonqualified retirement plan maintained by an employer solely for the purpose of providing benefits exceeding certain Internal Revenue Code limits on contributions to, and benefits from, qualified plans.

The benefits provided under a mirror plan are those benefits that would have been provided under a qualified plan, but for the limits on contributions and benefits described in the chart at left.
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Author:Janicki, Michael
Publication:The Tax Adviser
Date:May 1, 1996
Previous Article:Eleventh Circuit directs Tax Court to develop test for substantial understatement penalty.
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