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

avoid paying lawfully owed state taxes.

H.R. 371 by Rep. Stump would preempt state taxation of all pension income
earned by nonresidents. The Federation opposes this measure because of its
breadth. It is not targeted to the problem whicn has been presented. Further, there
are no definitions of what constitutes pension income which will undoubtedly lead
to lengthy and costly litigation to establish the parameters of the bill.

H.R. 744 by Rep. Rckett is similar to measures considered by this Committee in
other years. It would prohibit the states from taxing annuity income from certain
qualified plans and allow taxpayers a one-time exclusion for lump sum withdrawals
of up to $25,(X)0 from those plans. The concept of this bill is acceptable to state tax
administrators in that the preemption is limited and the focus is on the problem
identified. I would suggest, however, that the concept of differentiating between
lump sum and annuity payments should be examined and whether the one-time ex-
clusion presents some unnecessary complexity. (See also Statement of Gerald Gold-
berg, Executive Officer, California Franchise Tax Board.)

Unfunded Mandates

The second piece of legislation passed by the 104th Congress was S. 1, the Un-
funded Mandates Act of 1995, which declares that Congress shall resist placing ad-
ditional mandates on state governments without funding them and without studying
the revenue costs of such mandates. Here is an opportunity to show good faith to
that principle. H.R. 394 and the other measures constitute a mandate on state gov-
ernments. They require that states refrain from teixing in a manner which is other-
wise available to them. As such, they impose constraints on the generation of reve-
nues to meet the policy priorities as the state might establish them.

Moreover, that legislation when eflective will require that the Congressional
Budget Office estimate the cost of such mandates (including revenues states are pre-
vented from collecting) when they exceed $50 million annually. California estimates
that pending legislation will reduce its revenues by at least $25 million per year.
H.R. 394 should be properly viewed from its perspective as an unfunded mandate,
and all interested parties should be encouraged to pursue the recourse available to
them in state legislatures. (See also Statement of Gerald H. Goldberg, Executive Of-
ficer, California Franchise Tax Board, on this point.)



11 In point of fact, the section of law (IRC §3121(vX2)(C)) referencing nonqualified deferred
compensation plans is designed for the purpose of subjecting contributions to such plans to em-
ployment taxes as contrasted to a list of qualified plans, the contributions to which are exempt.



58

Conclusion

I conclude my remarks with this detail: For the record, if legislation is passed,
Congress should clarify in the Committee Report that state law definitions of resi-
dency are to be respected. There exists no federal counterpart definition and sub-
stantial case law has developed around state definitions of residency for state tax
purposes.

Thank you for the opportunity to appear. I will be happy to answer any questions.
We are also willing to work with the Subcommittee and its staff as these proposals
are considered.

Mr. Gekas. I thank the gentleman, and we turn to Mr. Johnson.

STATEMENT OF RANDALL L. JOHNSON, DIRECTOR OF
BENEFITS PLANNING, MOTOROLA

Mr. Johnson. Good morning, Mr. Chairman.

My name is Randy Johnson. I am director of benefits planning
at Motorola in Schaumburg, IL. I appear before you today on behalf
of the American Council of Life Insurance, the Association of Pri-
vate Pension and Welfare Plans, the Committee on State Taxation,
the ERISA Industry Committee, and the Profit Sharing Council of
America. These organizations are working together through the Re-
tirement Savings Network, a broad-based group of associations rep-
resenting employers and service providers concerned about em-
ployer-provided retirement plans.

I am accompanied by John Vine of Covington & Burling, legal
counsel to the ERISA Industry Committee.

I would like to begin today by telling you a little bit about Motor-
ola.

Mr. Gekas. Can you spell Mr. Vine's name?

Mr. Johnson. V-I-N-E.

Mr. Gekas. I should have guessed. All right. Thank you.

Mr. Johnson. I would like to begin today by telling you a little
bit about Motorola. I think this will help you understand why we
are so concerned about the State source taxes.

Motorola has 76,000 employees in the United States. We do busi-
ness in 50 States and around the world and commonly transfer em-
ployees from State to State and country to country. It is not un-
usual for a Motorola employee to work in from 5 to 10 States dur-
ing the course of his or her career.

We maintain two qualified retirement plans, a defined benefit
plan, commonly called a pension plan, and a defined contribution
plan, commonly called a profit-sharing or 401(k) plan. All 76,000 of
our employees are salaried and are hourly, are eligible to partici-
pate in both of these plans, and we administer both of them at Mo-
torola.

Our defined contribution plan accepts rollovers of payments em-
ployees have received from plans of their prior employers, and an
employee's average account balance in the defined contribution
plan is about $41,000. It is not uncommon for nonmanagement,
nonsupervisory employees, to have an account balance of as much
as $300,000 at the end of his or her career with our company.

In addition to our company contribution, this has resulted from
our encouraging employees to invest for the future and relatively
favorable investment returns, which is very important in a time
when all of us are concerned about the national savings rate.



59

Nearly all the benefits paid under the defined contribution plans
are paid as lump sum distributions. At many companies, lump
sums are also paid fi-om defined benefit plans. Motorola, like many
other companies, also has a nonqualified plan for employees with
compensation or benefits that exceed the limits that tax laws im-
pose on qualified defined benefit plans.

These plans are not — I emphasize not — just for upper-level ex-
ecutives. For example, sales people with unusually high earnings
in a given year can be covered by this plan. Technical and lower
to middle-level managers can also be found in these kinds of plans.

In this setting. State source taxes create insoluble recordkeeping
allocation and apportionment problems, not just for Motorola but
for thousands and thousands of retirees, employers, and plant ad-
ministrators who face similar problems.

It would be virtually impossible for a nonresident retiree to con-
test a tax assessment made by a distant State. First, the employee
will be unfamiliar with the State tax laws and unable to obtain any
records that might support his or her position. There is no reason
for the employee to have maintained such records.

Second, employers and plan administrators do not have the
records necessary to allocate retirement payments among States or
to allocate each payment between compensation for services and in-
vestment earnings. Employers and plan administrators have never
maintained records that refiect the benefit each participant has
earned in each State.

Like Motorola, an increasing number of plans now accept roll-
overs from other plans. In order to account for such distributions,
for the source of distributions, a plan accepting rollovers would
have to account not only for the benefits earned under that plan
but also for the benefits earned under the plans of prior employers.
Plans simply do not have the records that would permit them to
do this.

H.R. 394 addresses these problems by prohibiting any State from
imposing an income tax on the retirement income of an individual
who is not a resident or domiciliary of that State. We support this
approach. We oppose the narrower approach in H.R. 744. This bill
would provide only relief for certain qualified plans and, even then,
only for certain annuity and installment options and only for up to
$25,000 in benefits paid in any other form in a single year. These
restrictions prevent the bill from solving the problems created by
source taxes. In our judgment, the enactment of H.R. 744 would be
a worse solution than the enactment of no bill at all.

I thank you, Mr. Chairman, for the opportunity to testify and
would be pleased to respond to your question.

[The prepared statement of Mr. Johnson follows:]

Prepared STATEMEr>rr of Randall L. Johnson, Director of Benefits Planning,

Motorola

Mr. Chairman and members of the Subcommittee. My name is Randy Johnson.
I am Director of Benefits Planning at Motorola. Motorola is headquartered in
Schaumburg, Illinois, and produces high technology electronics products.

I appear before you this morning on behalf of the American Council of Life Insur-
ance, tne Association of Private Pension and Welfare Plans, the Committee On State
Taxation, the ERISA Industry Committee, and the Profit Sharing Council of Amer-
ica, all of whom participated in the development of this Statement. These organiza-
tions are working together through the Retirement Savings Network, a broad-based



60

group of associations representing employer and service providers concerned about
employer-provided retirement plans.

I am accompanied by John M. Vine of Convington & Burling, counsel to the
ERISA Industry Committee.

Summary of Position

The groups I represent strongly supfx)rt enactment of H.R. 394. This biU properly
addresses the enormous practical problems arising from the treatment of non-
residents' retirement income under State source tax laws.

Under State source tax laws, a retiree can be taxed on his retirement income by
each of the States in which he worked during his career, even though he does not
reside in, vote in, or benefit from public services in any of those States. As a result,
retirees can be taxed on the same income by multiple iurisdictions, and retirees, em-
ployers, and plan administrators face insoluble recordkeeping, allocation, and appor-
tionment problems. Unless States are prohibited from taxing nonresidents on their
retirement income, increasing numbers of retirees will be overtaxed, and more and
more retirees, employers, and plan administrators may be forced to endure an end-
less and mind-boggling tax-accounting nightmare. A nonresident retiree is in a weak
position from which to contest a tax assessment made by a distant State, especially
when he is unfamiliar with the State's tax laws and unable to obtain any records
that might support his position.

At present, only a small minority of States (less than a dozen) attempt to tax the
retirement income of nonresidents. Some States do not tax nonresidents at all; oth-
ers have the legal authority to do so, but do not attempt to tax their retirement in-
come as a practical matter. The judgment of the great majority of States is that it
is either inappropriate or impractical for a State to track down former residents to
tax their retirement income.

The fact that only a small number of States are involved makes it all the more
important that Congress act promptly before efforts to tax nonresidents' retirement
income spread. We are concerned that States whose residents are now being taxed
by other States might react to these efforts by attempting to collect their own in-
come taxes from residents of other States.

H.R. 394 addresses these problems by prohibiting anv State from imposing an in-
come tax on the retirement income of an individual who is not a resident or domi-
ciliary of that State. We support this approach.

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, we are concerned about the bill's failure to define
the critical term "pension income." The absence of a definition causes the bill's
meaning and effect to be uncertain.

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

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

State Source Taxes Overburden and Overtax Nonresident Retirees

If a State wishes to tax a nonresident on his retirement income, it may tax only
the portion of the retirement income that the retiree earned in that State. This is
known as "source taxation" because it seeks to tax income derived from sources
within the State. Source taxes require the retiree's retirement income to be allocated
among all of the States in which ne worked. A State may not tax a nonresident re-
tiree on retirement payments earned outside its jurisdiction.

In addition, although the courts are not all in agreement, a number of them have
treated the earnings on amounts deferred under a retirement plan as investment
earnings rather than as compensation for services. ^ A State may not tax investment
earnings realized by a nonresident. As a result, it also is necessary for a retiree to
allocate his retirement payments between compensation for services and investment
earnings.



^See. e.g., MoUer v. Dep't of Treasury, 443 Mich. 537. 505 N.W.2d 244 (1993); Pardee v. State
Tax Comm'n. 89 A.D.2d 294, 456 N.Y.S.2d 459 (N.Y. App. Div. 1982).



61

Retirees do not have the records needed to make these allocations. Retirees simply
have no reason to preserve compensation, employment, and retirement plan invest-
ment earnings records over periods of 30 or 40 years or longer. And retirees are not
able to obtain these records from their former employers, because employers do not
have these records either.

More fundamentally, there is no generally agreed upon way of allocating retire-
ment income among States. Certainly the States have not agreed on a uniform
methodology. The States do not even have a uniform definition of a "resident" of a
State; they have differing approaches to determining when income is attributable
to sources within the State; and they differ on the extent to which deferred com-
pensation is considered to consist of investment earnings as opposed to compensa-
tion for services.

Assume, for example, that an employee retires after 35 years of service with the
same employer under a pension plan that provides a benefit equal to 1% of the em-
ployee's final average earnings multiplied by his years of service, up to a maximum
of 30 years. If the employee worked in seven States during his career, each for a
period of five years, there is no generally agreed-upon method for allocating his re-
tirement income among the seven States. It is uncertain whether the portion of the
retirement income allocable to the last State in which he worked is worth zero be-
cause he had previously reached the 30-year limit on service, or whether the portion
of the retirement income allocable to that State should be increased to reflect a
large pay increase that the retiree received during his last five years of service.

In addition, the retiree has no way to identify the portion of the plan's investment
earnings allocable to his retirement income. Under a defined benefit pension plan,
there is simply no way to make an allocation of this kind; it generally is not mean-
ingful to allocate a distribution from a defined benefit plan between compensation
and investment earnings. Although it is theoretically possible to identify the portion
of a distribution from a defined contribution plan (such as a profit-sharing, 401(k),
or savings plan) that is allocable to the plan s investment earnings, a retiree does
not, as a practical matter, have (or have access to) the records needed to make such
an allocation.

The retiree will not receive any help from the State tax agencies. They do not
have the records either. A State agency typically taxes the entire amount of a retire-
ment distribution and puts the burden on the retiree to prove that he is not taxable
by that State on the full amount of the distribution.

Even apart from the lack of records and the absence of an agreed-upon methodol-
ogy, a retiree who has earned retirement benefits in more than one source-tax State
must file an income tax return in each State for each year in which he receives re-
tirement income. Given the mobility of our Nation's workforce, this is no small mat-
ter. It is not unusual for an employee to have worked in as many as five or six
states during his career, even while working for a single company. It is unreason-
able and unrealistic to expect a retiree to be able to familiarize himself with the
tax laws and tax filing requirements of five or six States with which he no longer
has any connection. In addition, a nonresident retiree is in a weak position from
which to contest a tax assessment made by a distant State, especially when he is
unfamiliar with that State's tax laws and unable to obtain any records that might
support his position.

Moreover, State source taxes subject many retirees to multiple taxation on the
same retirement income. Although States that impose income taxes provide credits
for residents who earn income in other States, tax credits do not work properly,
even in theory, unless the source tax States agree on the amount of retirement in-
come to be allocated to each State and the individual properly calculates and claims
them. The problem is that the States do not always agree on the allocation of retire-
ment income among States. And even where they do agree, this puts the burden
on the retiree to properly allocate his retirement income among the relevant States
and to calculate and claim the correct amount of the tax credit.

Many retirees are unaware of the availability of tax credits; others do not know
how to take advantage of tax credits or lack the records to do so; and in still other
cases, the statute of limitations prevents the retiree from taking advantage of tax
credits. A retiree often needs professional assistance in order to take advantage of
the available tax credits, and tnis only adds to the costs borne by the retiree.

And where a portion of the retiree's retirement income represents investment
earnings, as opposed to compensation for services, the potential for overtaxation by
source tax States is compounded, since there are no records that permit a retiree
who has worked in more than one State to identify the contributions and investment
earnings allocable to each State.

Retirees are justifiably enraged by State source taxes. Before their retirement, few
retirees are aware of the potential for multiple taxation. Multiple bills for back



62

taxes — often accompanied by demands for interest and penalties — frustrate their re-
tirement planning and severely threaten many retirees who are attempting to live
on fixed incomes.

Retirees justifiably view the imposition of a State source tax as fundamentally un-
fair. The tax is oflen imposed by a State with which the retiree has had little or
no contact for many years. The retiree does not live there, vote there, or use the
State's public services.

Because a nonresident retiree has no vote, and because few active workers are
even aware of the source tax. State legislatures have little or no incentive to re-
spond to nonresident retirees' needs. Under the circumstances, it is hardly surpris-
ing that many nonresidents believe that State source taxes subject them to taxation
without representation.

Although a nonresident retiree might once have benefited from the State's public
services, he was fully subject to the State's tax system at that time. Now that the
retiree resides in another State, he is responsible for paying taxes to that State, and
it is understandable that he is angry and upset when he receives demands from
other States for back taxes, interest, and penalties.

Employers and Plan Administrators Cannot Possibly Meet the Demands
That State Source Taxes Make on Them

Employers and plan administrators simply do not have the records necessary to
allocate retirement payments among States or to allocate each payment between
compensation for services and investment earnings. Employers anci plan administra-
tors have never maintained, and have never had any reason to maintain, records
that reflect the States in which each plan participant has worked, the period in
which each participant worked in each State, the compensation each participant
earned in each State, or the benefit each participant accrued in each State.

In the case of a defined benefit pension plan, this would require separate calcula-
tion of each participant's benefit in each State in which he worked. In the case of
a defined contribution plan, such as a profit-sharing, 401(k), or savings plan, this
would require the creation of a separate account for each State in which the partici-
pant worked in order to reflect employer contributions, employee contributions, and
investment earnings on a State-by-State basis. The burden of maintaining such
records would be monumental.

Similarly, employers and plan administrators have had no reason to keep records
that permit them to allocate retirement income payments between compensation for
services and investment earnings. As I have explained, in the case of a defined ben-
efit pension plan, it is not clear how a meaningful allocation could be made. In the
case of a defined contribution plan, a State-by-State allocation between compensa-
tion and investment earnings would require the plan administrator to create a sepa-
rate bookkeeping account for each State in which each participant worked, and to
establish separate subaccounts to reflect employer contributions, employee contribu-
tions, and investment earnings accrued in tnat State. The proliferation of accounts
would be extraordinary; it would impose enormous administrative and financial bur-
dens on employers and plan administrators. I am not aware of any plan in the Unit-
ed States that maintains such accounts, and I do not believe that there is one.

In response to the Unemployment Compensation Amendments of 1992, an in-
creasing number of plans now accept rollovers from other plans. In order to account
for the source of distributions, a plan accepting rollovers would have to account not
only for the benefits accrued under that plan but also for benefits accrued under
the plans of participants' prior employers. Plans simply do not have the records that
would permit them to do this. Plans do not, and cannot reasonably be asked to, ac-
count for benefits accrued under the plans of prior employers.

The Internal Revenue Service's new simplified tax and wage reporting system
("STAWRS") will not solve any of these problems. STAWRS will combine State and
federal information returns, and will give States access to the Federal Government's
data bank on wage and income information, but it will not solve the recordkeeping
and allocation problems that apply to nonresidents' retirement income. Although
STAWRS might increase a State's ability to track down its retired former residents,
and thereby magnify the problems I have described, STAWRS will provide no infor-
mation that will assist a retiree in avoiding excess State taxation.

State Source Taxes Undermine the Voluntary Employee Benefit System

Applying State source taxes to the retirement income of nonresident retirees
would undermine the voluntary employee benefit system and defeat the objectives
Congress sought to achieve when it enacted the Employee Retirement Income Secu-
rity Act of 1974 ("ERISA").



I



63

If plans were to maintain the records required to produce the information retirees
need to calculate their State source taxes, the plans' recordkeeping costs would sky-
rocket. Because a plan administrator cannot know in advance who will be liable for
source taxes, the plan would have to maintain records for all participants. As a
practical matter, the additional costs would be passed on to plan participants in the
form of reduced retirement benefits. All participants in all States would bear these
costs, even though only a relatively small number of States and a minority of par-
ticipants were directly involved.