Do employer-paid long-term disability payments count as an 'annuity' that qualifies for New York's pension and annuity income subtraction once the recipient turns 59 1/2?

Plain-English summary

Petitioner Diane M. Fortune became eligible for her employer's (Willis Corroon Corporation) long-term disability plan on December 11, 1993, after her disability - which will prevent her from ever returning to work - was certified. The plan, funded entirely by the employer and administered through Unum Life Insurance Company of America, pays her 70% of her basic monthly earnings (including other disability income), capped at $15,000/month, an amount that will not be affected by future increases in Social Security benefits. Petitioner turned 59 1/2 on May 16, 1994, and will keep receiving these LTD payments until age 65, when she converts to the Willis Corroon Pension Plan. She asked whether her LTD payments are an "annuity" within the meaning of Tax Law § 612(c)(3-a), which lets an individual age 59 1/2 or older subtract up to $20,000 a year of pension and annuity income from federal adjusted gross income when computing New York adjusted gross income.

The Department held that the payments do qualify as an "annuity." Although "annuity" is not defined in 20 NYCRR 112.3(c)(2)(i) (the regulation implementing the § 612(c)(3-a) subtraction), the Department applied the definition used for New York source-income purposes in 20 NYCRR 132.4(d)(2): a benefit that (1) is paid only in money, not securities or other property; (2) is payable at regular intervals, at least annually, for the recipient's life or at least half of her life expectancy; (3) is payable at a uniform rate, or a rate that varies only in specified permitted ways, with the total amount determinable at the annuity starting date; and (4) is evidenced by a written instrument or a definite written plan established by the employer. Following its own prior opinions in Richard J. Alexanderson (TSB-A-85-(2)I) and International Business Machines Corporation (TSB-A-83-(2)I), the Department reasoned that because Petitioner's LTD payments resulted from a permanent cessation of active employment due to permanent disability, and because those payments together with her later pension constitute one cohesive scheme of retirement benefits, the LTD payments satisfy every element of the annuity definition. Therefore, assuming the payments are included in federal adjusted gross income, up to $20,000 a year of the LTD payments Petitioner receives after May 16, 1994 qualifies for the Tax Law § 612(c)(3-a) subtraction.

What this means for you

Employees receiving employer-funded long-term disability benefits

If you are permanently disabled and unable to ever return to work, and your employer's long-term disability plan pays you monthly for life (or at least half your life expectancy) under a written plan, at an amount fixed or determinable when payments begin, those payments can qualify as an "annuity" for New York income tax purposes rather than being treated as ordinary disability pay. Once you turn 59 1/2, up to $20,000 a year of that income may be subtracted from federal adjusted gross income in computing your New York adjusted gross income, provided it is included in your federal adjusted gross income in the first place.

Employers/HR administering LTD plans that convert into retirement pensions

Where an LTD plan is structured so that a permanently disabled employee receives disability payments now and converts into the employer's regular pension plan at a set age (here, age 65), the Department treats the two payment streams together as one cohesive retirement-benefit arrangement. That structural link between the disability payments and the eventual pension - not the "disability" label on the earlier payments - is what allowed these payments to be characterized as an annuity, so plan design (employer funding, a fixed conversion age, a uniform payment formula) can affect how participants' payments are taxed in New York.

Common questions

Q: Why did it matter that Fortune's disability payments would later convert into a pension?
A: Following Alexanderson and IBM, the Department treats the disability payments and the subsequent pension payments as two series of payments under one cohesive scheme of retirement benefits, rather than as stand-alone disability pay - that combined structure is why the payments could be characterized as an "annuity."

Q: What must a payment stream satisfy to count as an "annuity" under 20 NYCRR 132.4(d)(2)?
A: It must be (1) paid only in money, not in the employer's securities or other property; (2) payable at regular intervals, at least annually, for the recipient's life or at least half of her life expectancy as of the date payments begin; (3) payable at a uniform rate, or a rate that varies only with asset-value fluctuation, a cost-of-living index, or the commencement of Social Security benefits, with the total amount determinable at the annuity starting date; and (4) evidenced by a written instrument executed by the employer or a definite written plan communicated to employees.

Q: Does the fact that future Social Security increases can't raise the benefit matter to the analysis?
A: Yes - it supports treating the payments as payable "at a uniform rate," one of the permitted rate structures under 20 NYCRR 132.4(d)(2)(iii), which helps show the benefit is a determinable annuity rather than a fluctuating disability payment.

Q: What would disqualify an LTD payment stream from being treated as an "annuity"?
A: If the disability were not permanent (so the arrangement did not represent a genuine cessation of employment leading into retirement), if payments were not made at regular intervals for life or at least half of life expectancy, if they were paid in property rather than money, if the total amount were not determinable at the annuity starting date, or if the right to payments were not evidenced by a written employer plan, the stream would fail the 132.4(d)(2) definition and would not qualify for the § 612(c)(3-a) subtraction.

Q: Does the subtraction cover all of Fortune's LTD payments, or only some?
A: Only up to $20,000 per year, and only for payments received after she reached age 59 1/2 on May 16, 1994; the payments must also be included in her federal adjusted gross income for the subtraction to apply.

Q: Is the $20,000 subtraction automatic once a payment stream qualifies as an annuity?
A: No. Tax Law § 612(c)(3-a) and 20 NYCRR 112.3(c)(2)(i) also require that the income be included in federal adjusted gross income, be received in periodic payments, be attributable to personal services performed before retirement (through an employer-employee relationship or a tax-deductible retirement plan), and be received by an individual who is 59 1/2 years of age or older.

Citations and references

• Tax Law § 612(a) - defines the New York adjusted gross income of a resident individual as federal adjusted gross income with certain modifications
• Tax Law § 612(c)(3-a) - allows a subtraction of up to $20,000 a year of pension and annuity income for taxpayers age 59 1/2 or older
• 20 NYCRR 112.3(c)(2)(i) - sets out the conditions (inclusion in federal AGI, periodic payments, attribution to personal services before retirement, age 59 1/2 or older) for the § 612(c)(3-a) subtraction
• 20 NYCRR 132.4(d)(2) - defines "annuity" for purposes of determining New York source income of a nonresident individual; applied here to interpret the undefined term in § 612(c)(3-a)
• TSB-A-85-(2)I, Richard J. Alexanderson - held that an employee's employer-funded long-term disability payments, made because of a permanent physical ailment and followed by conversion to a pension, constituted an "annuity" eligible for the § 612(c)(3-a) subtraction after age 59 1/2
• TSB-A-83-(2)I, International Business Machines Corporation - additional prior advisory opinion cited alongside Alexanderson for the same disability-then-pension cohesive-scheme analysis

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1998.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a98_5i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-98(5)I
Income Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I980120A

On January 20, 1998, a Petition for Advisory Opinion was received from
Diane M. Fortune, 4006 New York Avenue, Seaford, New York 11783.
The issue raised by Petitioner, Diane M. Fortune, is whether payments made
pursuant to Petitioner's employer's long term disability plan are an "annuity"
within the meaning of section 612(c)(3-a) of the Tax Law.
Petitioner submits the following facts as the basis for this Advisory
Opinion.
Petitioner was an employee of Willis Corroon Corporation until December 11,
1993, when she became eligible for her employer's long term disability plan.
Petitioner's disability will prevent her from ever returning to work. Petitioner
attained the age of 59 ½ on May 16, 1994. The long term disability plan is
contracted with Unum Life Insurance Company of America by Petitioner's employer.
Under the long term disability plan, when Unum receives proof that an
insured is disabled due to sickness or injury and requires the regular attendance
of a physician, Unum will pay the insured a monthly benefit after the end of the
elimination period of 180 days. The benefit will be paid for the period of
disability if the insured gives Unum proof of continued disability and regular
attendance of a physician. The maximum benefit period for an individual whose
age at disability is less than 60 years, is to age 65, but not less than five
years.
Under the contract with Unum, Petitioner is an eligible "Class 1" employee.
A "Class 1" employee is one who earns over $40,000 per year. For a Class 1
employee, "disability" and "disabled" mean, in pertinent part, that because of
injury or sickness the insured cannot perform each of the material duties of his
regular occupation.
Petitioner is covered under "Option B" of the plan. Under "Option B",
Petitioner is entitled to 70 percent of basic monthly earnings, including other
disability income, not to exceed a maximum benefit of $15,000 per month. "Basic
monthly earnings" means the employee's base salary plus production incentive
compensation averaged over the most recent 12 months.
The minimum monthly
benefit is at least $100. Once the plan was determined it could not be affected
by future increases in Social Security benefits. The entire cost of the plan is
funded by Willis Corroon Corporation.
Petitioner has been certified disabled by Social Security. Petitioner has
been receiving long-term disability payments since December 11, 1993. Petitioner
will continue to receive these payments until attaining age 65, at which time she
will convert to the Willis Corroon Pension Plan.

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Income Tax

Section 612(a) of the Tax Law defines New York adjusted gross income of a
resident individual as the individual's federal adjusted gross income with
certain modifications.
Section 612(c)(3-a) of the Tax Law contains a
modification for pension and annuity income, other than pensions and other
retirement benefits paid to public officers and public employees of New York
State, its political subdivisions or agencies or the federal government.
Section 612(c)(3-a) of the Tax Law and section 112.3(c)(2)(i) of the
Personal Income Tax Regulations ("Regulations") provide that pension and annuity
income not in excess of $20,000, received by an individual, may be subtracted in
determining the individual's New York adjusted gross income providing the
following conditions are met:
(a) the pension and annuity income must be included in federal
adjusted gross income;
(b) the pension and annuity income must be received in periodic
payments (except distributions from an individual retirement account
[IRA] or self-employed retirement plan [Keogh]);
(c) the pension and annuity income must be attributable to personal
services performed by such individual, prior to such individual's
retirement from employment, which arises from either an employer­
employee relationship or from contributions to a retirement plan
which are tax deductible under the Internal Revenue Code ("IRC")
(e.g., IRA or Keogh); and
(d) such individual receiving the pension and annuity income must be
59 and ½ years of age or over.
The term "annuity" is not defined in section 112.3(c)(2)(i) of the
Regulations, but is defined, for purposes of determining New York source income
of a nonresident individual, in section 132.4(d) of the Regulations as follows:
(2) Definition.
To qualify as an annuity, a pension or other
retirement benefit must meet the following requirements:
(i) It must be paid in money only, not in securities of the
employer or other property.
(ii) It must be payable at regular intervals, at least
annually, for the life of the individual receiving it, or over a
period not less than half of such individual's life expectancy as of
the date payments begin.
(iii) It must be payable:
(a) at a rate which remains uniform during such
life or period; or

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TSB-A-98(5)I
Income Tax

(b) at a rate which varies only with:
(1)the fluctuation in the market value of
the assets from which such benefits are payable;
(2) the fluctuation in a specified
generally recognized cost-of-living index; or

and

(3) the commencement of social security
benefits; or
(c) in such a manner that the total of the amounts
payable is determinable at the annuity starting date either directly
from the terms of the contract or indirectly by the use of either
mortality table or compound interest computations, or both, in
conjunction with such terms and in accordance with sound actuarial
theory. The term annuity starting date in the case of any contract
or plan is the first day of the first period for which an amount is
received as an annuity by the individual under the contract or plan.
(iv) The individual's right to receive it must be evidenced by
a written instrument executed by his employer, or by a plan
established and maintained by the employer in the form of a definite
written program communicated to his employees.
In Richard J. Alexanderson, Adv Op of St Tax Commn, March 19, 1985, TSB-A­
85-(2)I, it was held that the payments made to the petitioner from his employer's
long term disability plan, constituted an "annuity", as defined in section
131.4(d)(2)(iii) of the Regulations as amended on March 16, 1983 and applicable
to taxable years ending on or after December 16, 1982, and that the annuity
payments were subject to the exclusion provided for in section 612(c)(3-a) of the
Tax Law after the petitioner had attained the age of 59 ½ years of age. The
employee fully retired due to a physical ailment and will never be able to return
to any type of employment. All full time salaried employees under 64 ½ were
eligible for membership in the long term disability plan and the entire cost of
the plan was funded by the employer. If the employee was disabled longer than
6 months, monthly income from the plan would equal 60 percent of the employee's
base salary including other disability income up to a maximum benefit of $3,000
per month. Once the plan was determined, it would not be affected by future
increases in Social Security benefits. The plan provided a minimum benefit of
at least $100 per month, regardless of whether the employee received other
disability income. After the benefits started, they would continue up to age 65
or the date of retirement, if earlier.
In the advisory opinion, it was
determined that the long term disability payments were retirement benefits since
they were paid as part of a plan of payments made to an individual who was
permanently disabled, and thus embarked upon a permanent cessation of active
employment during which period he was to receive two series of payments, one from
the disability plan followed by one from the employee's retirement plan. The
payments were made in money at regular monthly intervals for life or at least
half of the life expectancy of the individual, treating the "disability" and

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Income Tax

"retirement" arrangements as constituting together a cohesive scheme of
retirement benefits. The total of the amounts payable was determinable at the
annuity starting date and the employee's right to receive the annuity was
evidenced by a written plan. (Also, see International Business Machines
Corporation, Adv OP St Tax Commn, April 5, 1983, TSB-A-83-(2)I.)
In this case, Petitioner was an employee of Willis Corroon Corporation
until December 11, 1993, when she became eligible for her employer's long term
disability plan. Petitioner's disability will prevent her from ever returning
to work.
The entire cost of the disability plan is funded by the employer and
under the plan, Petitioner is entitled to 70 percent of basic monthly earnings,
including other disability income, not to exceed a maximum benefit of $15,000 per
month. Once the plan was determined it could not be affected by future increases
in Social Security benefits. She will continue to receive these payments until
attaining age 65, at which time she will convert to the Willis Corroon Pension
Plan. Petitioner has been certified disabled by Social Security.
Like Alexanderson, supra, and IBM, supra, Petitioner's long term disability
payments are received as a result of her permanent cessation of active employment
due to permanent disability and are paid as part of a plan of two series of
payments, one from the disability plan followed by one from the retirement plan
and together these payments constitute retirement benefits. The payments are
made in money at regular monthly intervals for life or at least half of the life
expectancy of the individual. The total of the amounts payable is determinable
at the annuity starting date and Petitioner's right to receive the annuity is
evidenced by a written plan. Accordingly, the payments Petitioner receives from
her employer's long term disability plan constitute annuities under section
132.4(d)(2) of the Regulations and as contemplated under section 612(c)(3-a) of
the Tax Law. Therefore, assuming the payments are included in federal adjusted
gross income, up to $20,000 of the payments Petitioner receives a year from the
long term disability plan after May 16, 1994, will qualify for exclusion from
federal adjusted gross income when computing New York adjusted gross income,
pursuant to section 612(c)(3-a) of the Tax Law.

DATED: March 23, 1998

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.