By Darcy Norville
Hypothetical: Oregon executive will begin to receive payments from a nonqualified deferred compensation plan upon retirement. He plans to move to Washington state following retirement. Will the payments be subject to Oregon income tax?
The general rule is that Oregon taxes the income of Oregon residents and the "Oregon-source" income of nonresidents. Oregon-source income includes income from a business, trade, profession or occupation carried on in Oregon, even if received when the individual is no longer an Oregon resident. Therefore, under the general rule, the retired executive's deferred compensation is subject to Oregon income tax, because it is derived from employment in Oregon.
However, an exception for "retirement income," as defined under federal law, may apply. "Retirement income" received by a nonresident does not constitute Oregon-source income unless the individual is domiciled in Oregon. Assuming the retired executive has changed both his domicile (his permanent home) and residence to Washington before beginning to receive distributions from the deferred compensation plan, the question is whether the distributions constitute "retirement income."
Income from a nonqualified deferred compensation plan is "retirement income" if either:
- It is paid in substantially equal installments (not less often than annually) over a period of not less than 10 years, or for the life or life expectancy of the recipient (or the joint lives or joint life expectancies of the recipient and his or her designated beneficiary); or
- It is paid after termination of employment under a plan, program or arrangement maintained "solely for the purpose of providing retirement benefits" for employees in excess of limitations imposed by various qualified plan tax provisions.
There is no guidance on when a plan is maintained "solely for the purpose or providing retirement benefits" in excess of qualified plan limits. It is also unclear whether a plan that allows a participant to elect to receive distributions before retirement would qualify, even if the participant elected to receive payments after retirement. However, if the participant elected to receive benefits in substantially equal installments over 10 years (or longer), the first test would be met and the benefits should qualify as "retirement income."
The "retirement income" exception offers planning opportunities for companies contemplating adoption of a new deferred compensation arrangement for employees, as well as for participants in plans that offer distribution elections.
- Companies may wish to adopt a plan designed solely for the purpose of providing retirement income in excess of tax-qualified plan limits, or that permits or requires benefits to be paid in installment payment over 10 years or longer.
- Where available, employees may want to elect to receive plan benefits in installments over a period of 10 years or longer.
- Participants who have elected payments over a shorter period may wish to consider a change to their payment election, if permitted by the terms of the plan. However, it is essential that the change be permissible under the deferred compensation rules of the Internal Revenue Code.
For more information, please contact Darcy Norville (firstname.lastname@example.org, 503-802-2036) or Michael Millender (Michael.email@example.com, 503-802-2164), of our tax and employee benefits group.