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The Tax Man Cometh...Even in Retirement

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December 13, 2012 | Jennifer Namazi

The Tax Man Cometh...Even in Retirement

I know many retirees look forward to starting a new, carefree life free of winter weather, the 9 to 5 grind, and high tax brackets. One such retiree in Connecticut with similar hopes encountered a setback and learned the hard way about state-to-state mobility nuances after the New York State Division of Tax Appeals upheld the assertion that his stock option related income (and other deferred compensation income) received after retirement should be partially allocated to the state of New York, even though he resides in Connecticut.

Hungry States

State-to-state mobility is not a new topic. We know that states are becoming more assertive in claiming tax revenues associated with wages and benefits earned during the period of time the employee worked in their state, regardless of when the benefit was actually realized or paid. In many states, the employee never needs to reside there - only work there - in order for allocation claims to surface. In the appeals case at hand, an American Airlines employee resided in Connecticut during his employment and after his retirement. During his period of employment with the airline, he worked both in and outside of New York. He was granted a variety of stock options during his employment relationship with the airline (grants were awarded from 1996 - 2001, and again in 2003). The employee retired in 2005 and exercised his stock options in 2006. The state of New York maintained that a portion of the income from the transaction should be allocated to New York, reflecting the employee's time worked there. Like many other states, New York does have regulations requiring that non-residents pay income taxes on wages that are earned in the state (regardless of residency). There are a few exclusions on taxing non-residents mandated by federal law, such as that no non resident can be taxed on qualified retirement distributions. As a result, New York wanted the taxes from stock option gains based on the number of days worked in New York between the date of grant and the date of retirement. This translated to about two-thirds of the gains being taxable in New York.

The retired employee (who I'm guessing probably had no clue that he'd be taxed in New York, since he never lived there and was now well into retirement) challenged the New York Tax Division's claim to his income taxes on a number of grounds, including that the regulations were unfair to non-residents. Predictably, the New York State Division of Tax Appeals upheld all regulations in question.

They Don't Know What They Don't Know

This story is a good reminder that state-to-state mobility is not something that is going away. Even more troubling than learning how to administer the nuances of tracking and allocating income between states is the fact that many employees (regardless of employment status) have no clue about these intricacies. I'm thinking about the retiree that heads off to a warmer state with no state income tax, believing they've finally settled into retirement bliss. Moving to a state with no tax rate does not mean the employee is going to avoid paying state income taxes. They could very well owe the state they just left behind. While this may logically be entertained by current employees, and perhaps even those recently terminated, there is an aura around retirement that may cause many retirees to miss this concept in their tax planning.

Tax season is just around the corner, and it may be a good time to take a fresh look at the pool of possible current or former employees who may be subject to these very types of mobility issues and, at minimum, recommend that they take a hard look at the details with their tax planners.

-Jennifer

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