If a NYS Police and Firefighters Retirement System member rolls over a lump-sum distribution into an IRA, 457 Plan, or Roth IRA, how are later distributions from that account taxed for New York income tax purposes?

Plain-English summary

Lawrence Faraone was a member of the New York State Police and Firefighters Retirement System (NYSPFRS). Under Chapter 735 of the Laws of 2006, certain NYSPFRS members could elect an optional retirement benefit: a partial lump-sum distribution paired with a reduced service retirement allowance. Faraone was eligible to make that election, and he could choose to have the lump sum paid directly to him or rolled over, trustee-to-trustee, into an IRA, an Internal Revenue Code § 457 Deferred Compensation Plan, a Roth IRA, or another eligible retirement plan. He asked the Department how later distributions from whichever account received the rollover would be taxed for New York purposes.

The Department held that the rollover contribution itself is not included in New York taxable income under Tax Law § 612(c)(3)(i), which lets a taxpayer subtract pensions paid to officers and employees of New York State, its subdivisions, and its agencies. But once money sits inside a non-Roth IRA, 457 Plan, or similar plan, it mixes with other contributions and investment earnings, so later distributions have to be split. Following the approach used in a prior opinion, Albert Zelony, TSB-A-02(5)I, the Department said each distribution must be divided between the portion that represents a return of the NYSPFRS rollover contribution and the portion that represents other contributions or earnings.

The NYSPFRS-attributable portion of each distribution - calculated by multiplying the distribution by a fraction (NYSPFRS rollover contribution balance over current account value before the distribution) - qualifies for the § 612(c)(3)(i) subtraction. The remaining portion doesn't qualify for that subtraction, but if Faraone is age 59 1/2 or older, it may instead qualify for the separate $20,000 pension and annuity income subtraction under Tax Law § 612(c)(3-a) and 20 NYCRR 112.3(c)(2), combined with any other non-§ 612(c)(3) pension and annuity income he receives. Any excess above $20,000 remains taxable. After each distribution, the NYSPFRS contribution balance used in the tracing fraction is reduced, and the reduced balance carries forward to the next year's calculation.

If Faraone instead rolls the lump sum into a Roth IRA, the analysis is simpler: the rollover amount that is included in federal adjusted gross income under IRC § 408A still qualifies for the § 612(c)(3)(i) subtraction because it represents a return of his NYSPFRS contribution. And because qualified Roth IRA distributions are excluded from federal gross income under IRC § 408A(d), those later distributions are not New York taxable either.

What this means for you

If you're rolling over a NYSPFRS (or similar public pension) lump sum

A trustee-to-trustee rollover into an IRA, 457 Plan, or Roth IRA is not itself New York taxable income. But if you roll into a non-Roth account, you and your account administrator will need to track the NYSPFRS contribution balance separately from other contributions and earnings, because each future distribution must be apportioned between the two using the fraction described above - it isn't a simple "principal first" rule.

If you're 59 1/2 or older taking distributions from the rollover account

The portion of a distribution that isn't traceable to the NYSPFRS contribution doesn't disappear from tax consideration - it can still qualify for the ordinary $20,000 pension and annuity income subtraction under Tax Law § 612(c)(3-a), stacked together with any other qualifying pension and annuity income you receive. Amounts above that $20,000 combined cap are taxable.

If Roth IRA is the rollover destination

Rolling into a Roth IRA sidesteps the annual tracing calculation for future distributions: the rollover portion is subtracted under § 612(c)(3)(i) up front, and because IRC § 408A(d) keeps qualified Roth distributions out of federal gross income entirely, New York follows suit with no further apportionment needed.

Common questions

Q: Is the rollover itself taxed when it moves from NYSPFRS into an IRA, 457 Plan, or Roth IRA?
A: No. The rollover contribution is excluded from New York taxable income under Tax Law § 612(c)(3)(i) regardless of which type of account receives it.

Q: Once money is inside a non-Roth IRA or 457 Plan, how is a later distribution taxed?
A: It must be split. Multiply the distribution by a fraction - the NYSPFRS rollover contribution balance divided by the account's current value before the distribution - to find the tax-exempt, § 612(c)(3)(i) portion. The rest is either other contributions or earnings and doesn't qualify for that subtraction.

Q: What happens to the non-exempt portion of the distribution?
A: If the petitioner has reached age 59 1/2, that portion can qualify for the separate $20,000 subtraction under Tax Law § 612(c)(3-a) (combined with other non-§ 612(c)(3) pension and annuity income). Anything above $20,000 is taxable.

Q: Does the fraction used for tracing stay the same every year?
A: No. Each distribution that is treated as a return of the NYSPFRS contribution reduces that contribution's remaining balance, and the reduced balance is used as the numerator the following year.

Q: Does a Roth IRA rollover work the same way?
A: No, it's simpler. The rollover amount included in federal adjusted gross income under IRC § 408A qualifies for the § 612(c)(3)(i) subtraction, and because qualified distributions from a Roth IRA are excluded from federal gross income under IRC § 408A(d), those later distributions are not New York taxable either - no annual tracing fraction is required.

Citations and references

• Tax Law § 612(c)(3)(i) - subtraction from federal adjusted gross income for pensions paid to officers and employees of New York State, its subdivisions, and its agencies
• Tax Law § 612(c)(3-a) - $20,000 subtraction for pension and annuity income not covered by § 612(c)(3), available to taxpayers age 59 1/2 or older
• 20 NYCRR 112.3(c)(2) - regulation implementing the pension and annuity income subtraction
• Internal Revenue Code § 408A(d) - qualified Roth IRA distributions excluded from federal gross income
• Albert Zelony, Adv Op Comm T&F, July 24, 2002, TSB-A-02(5)I - prior opinion establishing that only the portion of a rollover IRA distribution representing a return of the NYS pension principal is exempt

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2009.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a09_9i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-09(9)I
Income Tax
July 28, 2009

Office of Counsel
Advisory Opinion Unit
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I080708D

Petitioner Lawrence Faraone, in a petition dated July 3, 2008, requests an advisory opinion
regarding the Personal Income Tax treatment of distributions from an Individual Retirement
Account (IRA), Internal Revenue Code § 457 Deferred Compensation Plan (457 Plan), Roth IRA or
other eligible retirement plan that was funded, at least in part, by a lump sum distribution that was
transferred in a direct trustee-to-trustee transfer from the New York State Police and Firefighters
Retirement System to the IRA, 457 Plan, Roth IRA or other eligible retirement plan.
We conclude that distributions that are attributable to a rollover contribution to an IRA, 457
Plan, or other eligible retirement plan that is not a Roth IRA are not included in New York taxable
income pursuant to §612(c)(3)(i). However, for an IRA, 457 Plan or eligible retirement plan that is
not a Roth IRA, any gain or income earned on the amount of the rollover is included in Petitioner’s
New York taxable income to the extent that it does not qualify for the $20,000 income subtraction
under Tax law §612(c)(3-a). For Roth IRAs, the amount of the rollover will not be included in
New York taxable income pursuant to §612(c)(3)(i) and, pursuant to Internal Revenue Code §
408A(d), the distributions will not be included in Federal gross income.
Facts
The Petitioner is a member of the New York State Police and Firefighters Retirement
System (NYPFRS). Chapter 735 of the Laws of 2006 provides that certain members of NYSPFRS
may elect to receive an optional retirement benefit consisting of a partial lump sum distribution and
a reduced service retirement allowance. At the member’s election, the lump sum can be either (i)
directly rolled over to an IRA, 457 Plan, Roth IRA, or other eligible retirement plan, or (ii) paid
directly to the member. Petitioner is eligible to elect to receive the optional retirement benefit.
Analysis
Section 612 of the Tax Law provides that the New York adjusted gross income of a resident
individual means the individual’s federal adjusted gross income with the modifications specified in
§ 612. Tax Law § 612(c)(3)(i) provides that, to the extent includible in gross income for federal
income tax purposes, pensions paid to officers and employees of New York State, its subdivisions
and agencies will be subtracted from an individual’s federal adjusted gross income (FAGI). Tax
Law § 612(c)(3-a) provides that, for pensions and annuities that are not subject to the subtraction
modifications provided by Tax Law § 612(c)(3), a taxpayer 59 ½ or older may subtract from FAGI
up to $20,000 of any of those pensions and annuities.

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TSB-A-09(9)I
Income Tax
July 28, 2009

In Albert Zelony, Adv Op Comm T&F, July 24, 2002, TSB-A-02(5)I, it was concluded that
when a taxpayer rolls over his or her New York State pension benefits to an IRA, the amount
received from the pension fund represents a nontaxable distribution, and is not subject to New York
personal income tax. Any subsequent distributions from the IRA will be exempt to the extent that
they represent a return of principal attributable to the pension rollover. Any other amounts received
will be subject to tax.
In this case, if the Petitioner rolls over the lump sum distribution to an IRA, then as in
Zelony, when the Petitioner receives distributions from the rollover IRA, only a portion of the
distribution is exempt. The portion of the distribution from the rollover IRA that represents the
rollover contribution from NYSPFRS is a return of the NYSPFRS contribution. If this portion of
the distribution is included in the Petitioner’s federal adjusted gross income, when the Petitioner
computes his New York adjusted gross income, the amount of the distribution that represents the
NYSPFRS contribution will qualify for the income subtraction under Tax Law § 612(c)(3)(i). This
result will be the same if the Petitioner rolls over the lump sum distribution into a 457 Plan or any
other type of qualified retirement plan other than a Roth IRA.
The portion of the distributions from a rollover IRA, 457 Plan, or other non-Roth IRA
qualified retirement plan that does not constitute a return of any contribution to NYSPFRS is not
exempt from New York State taxation. This portion of the distribution can consist of other
contributions to the rollover IRA, 457 Plan, or other non-Roth IRA qualified retirement plan, as
well as earnings on the amount of the NYSPFRS rollover and the other contributions. If the
Petitioner has reached the age of 59½, the balance of a distribution that does not represent a return
of the NYSPFRS contribution may be subtracted in computing New York adjusted gross income,
but only up to $20,000. (Tax Law § 612(c)(3-a) and 20 NYCRR 112.3(c)(2).) Any excess would
not be allowed as a subtraction from federal adjusted gross income when computing Petitioner’s
New York adjusted gross income.
Therefore, when the Petitioner receives a distribution from a rollover IRA, 457 Plan, or
other non-Roth qualified retirement plan, the Petitioner must determine the portion of the
distribution that is a return of the NYSPFRS contribution and the portion that is either a return of
other contributions or the gains earned by the rollover IRA, 457 Plan or other non-Roth qualified
retirement plan. The amount that will qualify for the income subtraction modification under Tax
Law §612(c)(3)(i) is determined by multiplying the amount of the distribution by a fraction, the
numerator of which is the NYSPFRS rollover contribution and the denominator of which is the
current value of the IRA before the distribution. As discussed above, the portion that does not
qualify for the subtraction modification under Tax Law §612(c)(3)(i) may qualify for the $20,000
income subtraction under Tax Law § 612(c)(3-a). This amount is determined by subtracting the
amount that is determined to be the portion that is the return of the NYSPFRS rollover contribution
from the amount of the distribution. Further, the portion of the distribution that is deemed to be a
return of the NYSPFRS rollover contribution reduces the balance of the NYSPFRS rollover
contribution in the IRA, 457 Plan, or other non-Roth qualified retirement plan. In the next taxable
year, when determining the portion of a distribution that is a return of the NYSPFRS contribution to
the rollover IRA, 457 Plan, or other non-Roth qualified retirement plan, the Petitioner will use the
most recently computed balance of the NYSPFRS rollover contribution in the numerator.

TSB-A-09(9)I
Income Tax
July 28, 2009

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If the Petitioner elects to rollover the lump sum distribution to a Roth IRA, any amount of
the rollover that is included in Federal adjusted gross income pursuant to Internal Revenue Code §
408A will qualify for the income subtraction under Tax Law § 612(c)(3)(i) because it is a return of
the Petitioner’s contribution to NYSPFRS. Pursuant to Internal Revenue Code § 408A(d), the
distributions from the Roth IRA will not be included in Federal gross income, and thus will not be
taxable in New York.
Accordingly, pursuant to Tax Law §612(c)(3)(i), the Petitioner is allowed to subtract from
the Petitioner’s FAGI the portion of the distribution from an IRA, 457 Plan, or other non-Roth
qualified retirement plan that is attributable to the Petitioner’s NYSPFRS rollover contribution that
is included in the Petitioner’s FAGI. Further, if Petitioner has attained the age of 59½, any
distributions from a rollover IRA, 457 Plan, or other non-Roth qualified retirement plan that do not
constitute a return of the Petitioner’s NYSPFRS rollover contribution may be subtracted from
Petitioner’s FAGI to the extent that the distributions, when added to any other pension and annuity
income that is not subject to the modification provided by Tax Law §612(c)(3), do not exceed
$20,000 and were included in Petitioner’s FAGI. If the Petitioner directs that the lump sum be
rolled over into a Roth IRA, the amount of the rollover will not be included in New York taxable
income pursuant to §612(c)(3)(i) and, pursuant to Internal Revenue Code § 408A(d), the
distributions will not be included in Federal gross income.

DATED: July 28, 2009

NOTE:

/S/
Jonathan Pessen
Director of Advisory Opinions
Office of Counsel

An Advisory Opinion is issued at the request of a person or entity. It is
limited to the facts set forth therein and is binding on the Department only
with respect to the person or entity to whom it is issued and only if the person
or entity fully and accurately describes all relevant facts. An Advisory
Opinion is based on the law, regulations, and Department policies in effect as
of the date the Opinion is issued or for the specific time period at issue in the
Opinion.