New York Advisory Opinion TSB-H-80(523)I: How is a distribution from an Individual Retirement Account taxed when the IRA was funded by a tax-free rollover of a New York State or local government pension?

Plain-English summary

Joseph W. Martiney asked the Department how New York personal income tax treats distributions from an Individual Retirement Account (IRA) that was established using a tax-free rollover of a pension paid from the State of New York or one of its subdivisions or agencies. Federal law (26 U.S.C. section 402(a)(5)) permits certain qualified-trust distributions to an employee or beneficiary to be rolled over tax-free into an eligible retirement plan, including an IRA.

Article XVI, section 5 of the New York Constitution exempts "pensions" (as distinct from ordinary salaries, wages, and other compensation) paid to officers and employees of the state and its subdivisions and agencies from taxation. Because the pension itself was constitutionally exempt, receiving it - and then rolling it over into an IRA - doesn't create a taxable event: the rollover is simply a repositioning of already-exempt funds, not new taxable income.

Looking ahead to when the IRA is later distributed, the Department drew a line based on the source of the money coming out. To the extent a distribution represents a return of the original rolled-over pension principal, it remains a nontaxable return of previously exempt funds. But to the extent a distribution represents interest or any other gain actually earned while the money sat in the IRA, that portion is new income earned inside a retirement account and is subject to New York personal income tax like any other taxable IRA earnings.

What this means for you

Retired state or local government employees who rolled a pension into an IRA

The portion of your IRA that traces back to your original exempt pension keeps that exempt character when withdrawn - you're not converting exempt pension income into taxable income just by moving it into an IRA. But any interest or investment gains the IRA earns afterward are taxable on withdrawal.

Anyone planning a pension-to-IRA rollover

The rollover itself is not a taxable event under either federal or New York law - tax consequences arise later, only when money actually comes out of the IRA, and only to the extent that money represents earnings rather than a return of the original rolled-over principal.

Accountants tracking basis in a rollover IRA

Keep records distinguishing the rolled-over exempt pension principal from subsequent earnings within the account, since only the earnings portion of future distributions is taxable - the principal portion retains its original exempt character indefinitely.

Common questions

Q: Is rolling my state pension into an IRA a taxable event in New York?
A: No - the rollover itself isn't taxable under either federal law (which permits the tax-free rollover) or New York law, since the underlying pension was already constitutionally exempt.

Q: When I later take money out of the IRA, is all of it tax-free since it came from an exempt pension?
A: No - only the portion that represents a return of the original rolled-over principal stays exempt. Interest or other gains earned inside the IRA after the rollover are taxable when distributed.

Q: Does this exemption apply to any pension, or only government pensions?
A: This ruling addresses specifically a pension paid by the State of New York or one of its subdivisions or agencies, which is exempt under Article XVI, section 5 of the New York Constitution - the analysis turns on that constitutional exemption carrying through the rollover.

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1980.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/h80_523i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-H-80 (523)I
Income Tax
February 2, 1981

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. I800630B

On June 30, 1980 a Petition for Advisory Opinion was received from Joseph W. Martiney,
549 Woolworth Building, Watertown, New York 13601.
The issue raised is the tax treatment, under the Personal Income Tax, of distributions from
an Individual Retirement Account established by means of a tax-free rollover of amounts received
in the form of a pension from the State of New York or a subdivision or agency thereof. The Internal
Revenue Code permits such tax-free rollovers of certain payments made from a qualified trust to an
employee, or an employee's beneficiary, which are transferred to an eligible retirement plan such as
an Individual Retirement Account. 26 U.S.C.A. §402(a)(5).
Article 16, §5 of the New York State Constitution provides that "All salaries, wages and
other compensation, except pensions, paid to officers and employees of the state and its subdivisions
and agencies shall be subject to taxation." Thus, the receipt of a distribution from a qualified trust
which constitutes such a pension is not subject to tax under the Personal Income Tax. The act of
"rolling over" the pension into an Individual Retirement Account is not itself a taxable event, and
a subsequent distribution from such an account would represent a nontaxable return of principal to
the extent that the distribution represented a return of funds "rolled over" into the account. To the
extent that the distribution represented interest, or any other type of gain, earned in the account such
portion would be subject to tax.

DATED: November 24, 1980

JAMES H. TULLY., COMMISSIONER

s/LOUIS ETLINGER
Deputy Director
Technical Services Bureau

LOUIS M. JACOBSON, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR