State taxation of nonresidents' pension income : hearing before the Subcommittee on Commercial and Administrative Law of the Committee on the Judiciary, House of Representatives, One Hundred Fourth Congress, first session, on H.R. 371, H.R. 394, and H.R. 744, June 28, 1995 online

The recordkeeping costs are likely to be so substantial that many employers will
choose to terminate existing plans, or refrain from adopting new plans, rather than
spend money that will be invested largely in recordkeeping. Many employers will
rationally decide that their limited resources should be spent on current compensa-
tion rather than on retirement benefits that are diluted by recordkeeping expenses.

All of this will undermine the Congressional policy favoring the establishment of
voluntary employee benefit plans. Congress sought to avoid such situations when it
included a broad preemption provision in ERISA. Congress recognized that employ-
ers, which are not required by ERISA to adopt employee benefit plans, are far more
likely to do so if they can administer a plan efiiciently and free from interference
from varying State laws. As the Supreme Court observed,

A patchwork scheme of regulation would introduce considerable inefii-
ciencies in benefit program operation, which might lead those employers
with existing plans to reduce benefits, and those without such plans to re-
frain from adopting them.

Fort Halifax Packing Co. v. Coyne, 482 U.S. 1, 11 (1987).

As a result, any State law that sought to require an ERISA-governed plan to
maintain records implementing the State's source tax should be preempted by
ERISA. But preemption alone does not solve the problem from the plan's standpoint.
As long as retirees are potentially subject to State source taxes, retirees will be at
risk, and employers and plan administrators will be besieged with requests for in-
formation from them regarding the sources of their retirement income.

Retirees should not be put in the position of being overburdened and overtaxed
by State source taxes. Employers should not be put in the position of being discour-
aged from offering retirement plans or put in the position offering retirement plans
and then being unable to provide retirees with the information they need to deal
efiectively with State tax agencies.

The State Source Tax Problem Is Not Analogous to the Expatriate Problem

At the 1993 Subcommittee hearing on State taxation of nonresidents' pension in-
come, questions were raised as to whether the efforts of the State tax agencies are
any difterent from the efibrts of the Federal Government to tax the pension income
of a U.S. citizen who has retired to a foreign country.

Although the Federal Government has an interest in taxing the retirement income
of U.S. citizens who retire abroad, the Internal Revenue Service's enforcement ef-
forts do not create the same practical problems that arise when States seek to tax
nonresidents on their retirement income. Employees retire abroad far less fre-
quently than they retire in other States. And because there is a single Federal Gov-
ernment (as compared to 50 States), the allocation issues that arise at the State
level rarely arise when a U.S. citizen moves abroad. The two situations are not com-
parable.

At the federal level, because all of the retiree's income is typically attributable to
services in the United States, there is no allocation problem; all of the retiree's in-
come is allocable to the United States. By contrast, State source taxation requires
the retiree's retirement income to be allocated among all of the States in which he
worked; a State may not tax a nonresident retiree on retirement payments earned
outside its jurisdiction. And as I have explained, there are no records that permit
these allocations to be made and no generally agreed-upon methodology for making
the allocations.

Similarly, at the federal level, it is unnecessary to allocate each retirement pay-
ment between compensation for services and investment earnings; the Internal Rev-
enue Service treats all retirement plan distributions as compensation for services.
By contrast, at the State level, such allocations may be necessary because a State
is not permitted to tax investment earnings realized by a nonresident. As I ex-
plained earlier, where a retiree has worked in more than one State, there are no
records that identify the investment earnings attributable to each State in which
the retiree worked.



64

We Support H.R. 394

H.R. 394 prohibits any State from imposing an income tax on the retirement in-
come of an individual who is not a resident or domiciliary of that State. The bill
broadly defines the operative term "retirement income." The bill is not limited to
certain types of qualified plans or to benefits paid in certain forms or to benefits
under a specified dollar limit.

We think that H.R. 394 takes the proper approach. We strongly support it.

While We Support the Objectives of H.R. 371, We Are Concerned About Its
Consequences

H.R. 371 prohibits a State from imposing an income tax on the "pension income"
of any individual who is not a resident or domiciliary of that State.

Although we support the objectives of H.R. 371, and we commend the bill's spon-
sors for seeking to address the source tax problem, we are concerned about the bill's
failure to define the critical term "pension income." The bill's failure to define this
term creates substantial uncertainty about the bill's meaning and eflect.

We think it would be a mistake for Congress to attempt to address the State
source tax problem by enacting H.R. 371 without clarifying the meaning of the bill.
If H.R. 371 is enacted, there doubtless will be a lengthy jjeriod during which the
bill's meaning will remain uncertain. Litigation probably will be required to resolve
many of the questions raised by the bill. A lengthy period of uncertainty and litiga-
tion will be contrary to one of the bill's principal objectives: to relieve retirees of
uncertainty and worry about their State tax obligations.

By contrast, H.R. 394 defines "retirement income," the comparable term in that
bill. We strongly prefer the approach taken by H.R. 394.

We Oppose H.R. 744

H.R. 744 would provide relief only for certain types of qualified plans and, even
then, only for benefits paid in certain annuity or installment forms and only for up
to $25,000 in benefits paid in any other form in a single year. These restrictions
will prevent the bill from solving the problems created by State source taxes. In our
judgment, enactment of H.R. 744 would be worse than no bill at all. We oppose H.R.
744.

The narrow focus of the bill could actually harm retirees who receive retirement
payments that are not exempt from State source taxes under the bill. By exempting
only certain retirement payments, and not others, the bill might invite more States
to tax those nonresidents who receive nonexempt retirement payments. The bill
would, for the first time that we are aware, provide Congressional support for State
taxation of nonresidents' retirement income. Thus, ironically, although H.R. 744
mav be a well-intentioned efTort to limit State source taxation, it could actually
make a bad situation worse by giving official Congressional support to the taxation
of nonresidents' retirement income.

The bill's narrow focus would leave unprotected millions of retirees, including re-
tired rank-and-file employees. There is no equitable or principled reason for provid-
ing relief for certain types of retirement plans but not for others, for providing relief
for certain forms of payment but not for others, or for providing relief for small pay-
ments but not for larger payments.

The bill would not protect a retiree who receives a payment from a retirement
plan in the form of a lump-sum distribution exceeding $25,000. Rank-and-file em-
ployees who work for an employer for a significant period of time are likely to have
benefits well in excess of $25,000. The bill also does not appear to protect the retiree
who receives a lump-sum distribution of more than $25,000 even if the retiree then
rolls the distribution over into an IRA or other tax qualified plan.

Likewise, the bill would not protect a retiree who receives a distribution from a
nonqualified plan. Because of tne recent reductions in the Internal Revenue Code
limits on tax-qualified plans, increasing numbers of rank-and-file employees are now
expected to receive retirement income from nonqualified plans.

But the problems go well beyond this. All of the recordkeeping and administrative
problems now created by State source taxes will remain under H.R. 744. An em-
ployer or plan administrator cannot know in advance whether an employee will elect
to receive his retirement income in a lump sum or as an annuity. Nor can an em-
ployer or plan administrator identify in advance the employees who will become en-
titled in the future to benefits exceeding the limits established by H.R. 744. As a
result, the recordkeeping and administrative problems that arise today will continue
unabated under H.R. 744. H.R. 744 ofTers no solution; in fact, as I have explained.



65

it could make matters worse since it might actually encourage more States to tax
nonresidents on their retirement income.

This comoletes my prepared statement. I wish to thank the Chairman and the
members of the Subcommittee for the opportunity to testify. I will be pleased to re-
spond to any questions that the Chairman or the members of the Subcommittee
might have.

Mr. Gekas. Yes, thank you very much.

This testimony is very valuable to us, and I state now, as I have
stated many times before, this subcommittee has acted on legisla-
tion that has come before it as a result of the testimony of the wit-
nesses that had preceded in mind. Many of the final decisions
made by this subcommittee on language in a particular bill re-
flected positions for and against such propositions presented by the
various witnesses. So we want you to know that this is well re-
ceived by us.

The question that I wanted to ask right at the start to Mr. Dun-
can was his assertion, which seemed to me beneficial, that the
States are moving out of this and by themselves are taking the op-
tion of not taxing nonresidents. If that be the case, then all that
Congress would be doing if we follow through is closing the final
door as it were. Don't you see a salutary position here for the Con-
gress in that regard?

Mr. Duncan. I think the point that I was trying to make, Mr.
Chairman, was that States in particular are moving out of the tax-
ation of the annuity income for — annuity payments to non-
residents — that is, the periodic monthly check, the type of program
that California has — ^because of the difficulty that you have in
doing it in an evenhanded fashion.

Those, however, who confine their taxation primarily to the non-
qualified area, there has been New Jersey that has moved away
from that, but that is a larger group, and I think they feel they can
administer that in a fashion which is acceptable to them, and you
don't see a lot of movement out of there. The point I was trying
to make is, there is not a headlong rush of the States to try to step
into this area, tax annuity payments, or if you put a ceiling that
said the first $30,000 is exempt, that you would see any large num-
ber of States moving in to tax that above $30,000.

Mr. Gekas. Would you feel better if we left the nonqualified, the
unqualified out of this mix and just concentrated on the qualified?

Mr. Duncan. I think our folks would feel a lot better about that,
Mr. Chairman.

Mr. Gekas. All right, thank you.

Mr. Johnson, I, too, gather from your testimony that you were
considering and describing the Motorola plans, the qualified plans,
as what you would want to see not be targets of this type of tax-
ation, source taxation. You leave the question of nonqualified open
because Motorola doesn't engage in any nonqualified. Isn't that cor-
rect?

Mr. Johnson. Well, if I have communicated that, I have
miscommunicated, and let me try to start again.

Mr. Gekas. Yes, I would like that.

Mr. Johnson. First, I would like to also address your question
to Mr. Duncan. We believe that the recent history in the House and
Senate in looking at this subject potentially has given the States
an indication of how much of an appetite there is lor States to tax,



66

but if, in fact, this kind of a bill is not passed, that more and more
States will in the future tax just to recoup the taxes that they are
having taken from their residents and now going to California.

With respect to the nonqualified plans, there is a gross mis-
understanding regarding who is in nonqualified plans. We have
heard earlier and outside of this room that there is a perception
that nonqualified plans cover primarily senior executives. That
couldn't be further from the truth. As a matter of fact, these
plans — Motorola's, as well as many other companies — cover senior
technicians like engineers, they cover middle-level managers, they
cover sales people, and others. Secondly, these plans accrue bene-
fits over a significant period of one's career, not just one or two.

So the implication that nonqualified plans are designed to avoid
taxes in a significant proportion of cases, if not virtually all, is not
consistent with what actual practice is in the companies. Therefore,
we believe it is inappropriate to tax the nonqualified plans, just
like the qualified plans.

In addition to that, just like for the qualified plans, we don't
have the records to determine what the source of the retirement
benefit is — that is, what State. The same applies to nonqualified
plans, again, because these benefits accrued in these kinds of plans
are accrued over a period of time.

Mr. Gekas. Mr. Hoffman, I don't know if it has been made clear
to us by previous statements, but the time of the chairman has ex-
pired. I will come back to you in my second round.

The gentleman from Rhode Island.

Mr. Reed. Thank you, Mr. Chairman.

Mr. Johnson, how many employees does Motorola have?

Mr. Johnson. 76,000.

Mr. Reed. And how many would be in qualified pension plans,
do you know?

Mr. Johnson. 76,000, all of our hourly and salaried employees,
and in most companies of significant size qualified plans cover most
plans, most employees.

Mr. Reed. How many would be in nonqualified plans, Mr. John-
son?

Mr. Johnson. Someplace today in our corporation, probably four
to five hundred people.

Mr. Reed. So you have 76,000 employees who are in qualified
plans, and you have 400 in nonqualified plans.

Mr. Johnson. Right.

Mr. Reed. Thank you.

And either Mr. Duncan or Mr. Johnson, because I think you are
both expert in these issues, could you, for mv benefit, explain the
basic differences between a qualified plan ana a nonqualified plan?
What are the limits? What pushes you into a nonqualified plan?

Maybe Mr. Duncan can start. You can add, Mr. Johnson.

Mr. Duncan. I certainly wouldn't want to be considered an ex-
pert in this area, but based on the research I have tried to do for
this, it is my understanding that nonqualified plans have certain
characteristics to them.

First of all, there are no contribution limits imposed on them
under the Internal Revenue Code. Second, there is no requirement
for universal coverage of the employee work force or any class of



67

the work force. The third is that there is not necessarily a time pe-
riod in which they need to be withdrawn. In other words, there is
no 59V2 rule or IOV2 rule.

I guess those are the three — three or four primary differences be-
tween nonqualified plans and what we consider normal retirement
income, which has always to this point been the focus of this bill.

Mr. Johnson. Increasingly the Internal Revenue Code has placed
limits on the amount of benefits a person can accrue, and in most
cases these plans are designed to cover those people whose benefits
might exceed a limit in a particular year in other years, and it is
important to note that many of these plans are part of the ERISA
legislation and follow ERISA guidelines.

Mr. Reed. Now, Mr. Johnson, you make a point, which is a legiti-
mate one, about, this is not just the two or three chief executives
of the company but it is a rather small group of people.

If your company is representative of other companies, and I
think there is the possibility, and I am not suggesting Motorola or
any company, but the possibility of a — particularly in small compa-
nies, in fact, where compensation could be arranged so that there
is a conscious and legal effort to avoid State taxes, I think we have
to be sensitive to that, and that is one reason where this bright
line, at least between qualified and nonqualified, while maybe not
satisfying everyone, at least is an attempt at this juncture to deal
with that possibility.

Let me ask another question, because an interesting point was
brought up in the chairman's questioning of Professor Smith, and
that is this notion of, does it make any sense to have a $30,000 ex-
emption, given all the practical problems of tracing income and cal-
culating income, et cetera? And since you represent the tax admin-
istrators, Mr. Duncan, why should we support any type of exemp-
tion? Shouldn't it be sort of, everything is taxed or nothing is
taxed? All qualified or just nonqualified, et cetera?

Mr. Duncan. I would make two points in that regard. The first
is that the change that this committee made last year to the bill
as it was introduced I think was an important one. Previously, the
limit was $25,000, once in a lifetime on a lump sum withdrawal,
and this committee said it is $30,000 a year regardless of the type
of withdrawal. I think that was an important and beneficial
change, both for consistency across people and understandability.

The second, as to, should there be a cap of any sort? I guess the
perspective that we have taken is that we want to address the real
problems that exist out there. Data that I have seen indicated a
couple of years ago that a ceiling of $20,000 a year on the pay-
ments out of the California public employees retirement system
would have covered something well in excess of three-fourths of the
retirees at that point, if not more.

So we wanted to address the problems at hand and avoid the po-
tential for arrangements that would lead to tax avoidance, and that
is why the idea of a cap was put in the bill.

Mr. Reed. Thank you, Mr. Chairman.

Mr. Gekas. The gentleman from Virginia.

Mr. Scott. Thank you, Mr. Chairman.



68

Maybe I am missing something. I thought the major difference
in a quaHfied plan and nonquaHfied plan is the nonqualified was
after- tax money. Is that not true?

Mr, Johnson. That is not true in any case that I can recall,
though there might be specific reasons to do that.

I think, Congressman Scott, there is another reason for non-
qualified plans, and that is, increasingly, as we become global com-
panies, people will earn some of their retirement income in coun-
tries other than the United States, and in order to have those peo-
ple who are traveling overseas — and, again, this is not merely sen-
ior management, this is a trend of our whole management progres-
sion — in order for us to provide protection for a loss of retirement
benefits, not just for senior executives but any person who is trav-
eling overseas, we will increasingly have and have today non-
qualified plans to make up for protection of that kind of money.

I also want to make one other point. Whether it is a $30,000 cap
or whether it is a nonqualified plan, the problem exists — and, Con-
gressman Scott, you pointed out earlier today, there are no records
that companies can provide to allow a person, much less the com-
pany, to calculate that tax.

Mr. Scott. Well, as your employees move around to different
plants in different States, do you withhold State tax for each of
those States where they are actually working?

Mr. Johnson. We do withhold taxes for States obviously, but we
have not retained those kinds of records down through the years,
and a person might be living in one State, working in another, and
I think some of those

Mr. Scott. I would be interested in the source State where the
money is being made.

Mr. Johnson. Where the money is — I'm sorry?

Mr. Scott. Is being made. And how long do you keep your
records?

Mr. Johnson. I have not looked at the exact records but merely
long enough to meet the Internal Revenue Code retirements.

Mr. Scott. Three to five years? Is that about it?

Mr. Johnson. Maybe.

Mr. Scott. What has been your experience with California and
other States going after some of your employees for source taxes?

Mr. Johnson. Our particular experience has not been as great
as that described by Mr. Hoffman. Our concern is the

Mr. Scott. Wait a minute. I assume Mr. Hoffman's situation has
a lot of State employees where the State has the check and can es-
sentially garnish the check. For a private employer, you haven't
seen that much — is that because you don't have plants in Califor-
nia and a couple of other States?

Mr. Johnson. A predominant number of other employees are not
from California. Only a small segment come from California and
some of the other States where there are taxes.

Our concern is the potential increase for the future. If this kind
of legislation is not enacted, we think that there will potentially be
other States that will increase their aggressive behavior in this
area.



69

Mr. Scott. Mr. Hoffman, I assume that most of your members
are either State employees or people that have gotten caught up in
and hit with deficiencies.

Mr. Hoffman. No, that is really not true. I would say our mein-
bers are equally divided between military, State, Federal, and, pri-
vate. I have a private pension. I haven't found it on Internet yet.
I will. California, I believe, has a law that requires their employees
to report this. I have a paper in front of me which

Mr. Scott. Say that again.

Mr. Hoffman. They have a law which requires the companies
within the State of California to report their nonresident employees
by Social Security number, et cetera.

Now, the reason I didn't submit the document that is in front of
me is, we got it from a member out of the Franchise Tax Board and
the legislator who is studying ways to combat our effort to stop
this. It was done in 1992. But an attachment to that particular one
says "notice requirements," and one of the requirements says that
every employee is required to provide the Franchise Tax Board
with the name. Social Security, last known address, and number of
years of service the employee performed service for the employer.
I believe that is in their law. But if you have ever looked at Califor-
nia's laws, you would find that their table of contents for their tax
codes is over 50 pages. So I am having trouble finding it, but I will
at some point.

Mr. Scott. Thank you, Mr. Chairman.

Mr. Gekas. I thank the gentleman.

One other question I have on my abbreviated second round, and
that is, I have never, through all the testimony that I have heard
now for several years, determined whether in the California system
for collecting the tax is withholding or billing. Which is it?

Mr. Hoffman. The system in California is billing. They have
passed laws that allow them to use collection agencies, which is
probably the worst part of this, because most of the retirees are un-
aware that they owe any taxes and then all of a sudden they get
this enormous bill — I forget the form number — that says you owe
these taxes. Usually that amount is incorrect and, interestingly
enough, is always higher than what the retiree would really owe.

Mr. Gekas. So they don't withhold at the source on the pension
check.

Mr. Hoffman. No, they don't, although in the Ford Rockwell let-
ters that were sent to their employees, they told their employees
to please tell them which States they work in, which substantiates
Mr. Johnson's point that the companies didn't know, and, if they
did not, they were going to send forms to every State that Rockwell
or Ford, as the case may be, had business in, and they threatened
to withhold taxes for States up to the amount that — you know,
comparable proportionate amount that was withheld on Federal.

Now of course you are not required as a retiree to have withhold-
ing on Federal. So I guess you could cancel that and they could still
send collection agencies after you.

The question that was asked earlier on how many States this af-
fects, our organization has members from every State in the Union;
we have members in Saudi Arabia, Mexico, Canada; you can't be-
lieve it. Now it is true, most of these cases have to do with Califor-



70

nia going after people, but not all of them, and I think if you read