State taxation of former residents’ pensions

State taxation of former residents’ pensions

William H. Sager

State Taxation of Former Residents’ Pensions

The state income taxation of the pensions of former residents of the state is an oppressive tax known as the “source tax.” The name is derived because the states that impose the tax upon their former residents consider themselves to be the source of the pension benefits earned within the state but now received elsewhere.

One of the prevalent examples of the source tax is the state of California. A number of taxpayers who earned their pensions while living and employed in California upon retirement moved to Nevada where there is no state income tax. As a source tax state, California follows and attempts to collect its state income tax on the now out-of-state taxpayer’s pension. California is telling non-resident taxpayers that they owe California income tax on their pension income because they qualified for and earned the pension while they were residents of California. Moreover, the non-resident taxpayers (whose ties to California are now completely severed) are informed that they will owe the California income tax on their pension income for as long as they receive it – presumably, the rest of their lives.

California and the other states that employ the source tax rationalize their action by considering that they were the source of the pension benefits and the taxpayers, as residents while earning the pension benefits, used the state’s services and facilities. The taxpayers (now retirees) argue that they paid taxes as a state resident while using the state’s services and now that they are retirees and their incomes are reduced they have no further obligation as a non-resident not currently using state services to be taxed on their pension income. Moreover, the non-resident retirees argue that a tax on pension income is a tax on intangibles and the situs of an intangible tax is the place where the owner of the intangibles is located.

The following states tax the pensions of individuals who no longer reside or have any connections within the state: Arkansas, California, Idaho, Iowa, Kansas, Massachusetts, Maryland, New York, Oregon, Utah, Vermont and Virginia. Retired taxpayers who receive a pension are rightfully concerned whether the above 12 source tax states will follow them to their retirement resident states and attempt to collect income taxes on their pensions.

Several retirement states that do not have an individual state income tax have enacted laws forbidding another state to seize the property of their residents for non-payment of the source tax. Nevada and Florida have enacted such protection laws and Texas is considering one.

Meanwhile, since the current situation between California and Nevada has engendered controversy and apprehension on the part of California retirees who are now residents of Nevada, it was only natural that the Nevada congressional delegation would become involved. Representative Barbara Vucanovich (R-NV) believes the source-tax is clearly unfair and discriminatory. On January 3, 1991, she introduced H.R. 431 (referred to the House Judiciary Committee) which would ban the state source tax on the non-residents’ pension income that the retirees earned before their retirement and before moving to another state.

On June 12, 1991, Rep. Vucanovich testified before the Senate Finance Committee’s Subcommittee on Taxation and Debt Management in support of S. 267 (introduced by Nevada Senator Harry Reid), which would prohibit a state from imposing an income tax on the pensions of individuals who no longer reside in that state. “Many states across this country have the source tax law on their books and can activate collection procedures at any time. States that are already collecting the tax, like California, charge high penalties and daily interest fees but are in many cases delinquent in notifying the taxpayers of the tax. This creates huge interest penalties and an overwhelming tax burden on this nation’s senior citizens,” said Rep. Vucanovich. “But these states are not satisfied with this already enormous amount; they want more. So they tax not only the pension income, but all other sources of the retiree’s income regardless of the state in which the money was earned. Simply stated, this is taxation without representation.”

On March 22, 1991, Rep. Vucanovich introduced a second bill aimed at stopping the taxing of non-residents’ pension income. The second bill, H.R. 1655 provides that no deduction shall be allowed for certain taxes paid to states that tax nonresidents on pension income in an unfair manner. However, any state intent on maintaining its source tax on non-residents’ pension income would be required to provide the taxpayers with advance notice of the tax and allow the taxpayer an opportunity to prepay the tax before leaving the state, and implement a taxing formula that does not include income from any other state. Since H.R. 1655 amends the Internal Revenue Code of 1986, it was referred to the Committee on Ways and Means.

The source tax is an opportunity for independent practicing accountants and their affiliated state organizations to flex their political muscle. Expressions of support to Rep. Vucanovich for H.R. 431 and H.R. 1655 are certainly in order. Just as important, letters of support to members of the committees before whom those two bills are pending would be appropriate. As in all cases, please send NSPA’s Director of Federal Affairs a copy of your letter and any response received.

NSPA’s affiliated state organizations possess considerable political clout on the state level. If your state is one of the dozen states (listed previously) that imposes a source tax on non-residents’ pension income, exercise your influence to get the legislature to rescind or modify the tax. No one is more familiar with the state’s tax structure than the independent practicing accountant. The accountant recognizes problems of tax avoidance, tax compliance and tax fairness and equity and is just as familiar with what is involved in the characteristics of a tax as are most legislators.

The issue of the source tax is a window of opportunity for the independent practicing accountant to express concerns to the federal Congress and to the state legislature. The rewards for doing so are name recognition, organizational recognition and the opportunity to be involved in an issue of fairness and taxpayer fair treatment.

COPYRIGHT 1991 National Society of Public Accountants

COPYRIGHT 2008 Gale, Cengage Learning