State-Federal Tax Differences Could Cause Plan Problems

December 7, 2001 ( - Retirement plan participants could have to pay state income tax next year on money contributed to their plan on a federal tax-deferred basis. Participants could suffer the same state tax problem with certain rollover money.

At the very least, sponsors and participants could both be in for a recordkeeping nightmare if states don’t change their tax codes to mirror the liberalized plan-contribution rules scheduled to go into effect in the federal tax code in 2002.

A report recently prepared by Fidelity Investments cited on lists the following states in the problem category: Alabama, Arizona, Arkansas, California, District of Columbia, Georgia, Hawaii, Idaho, Indiana, Iowa, Kentucky, Maine, Massachusetts, Minnesota, New Jersey, North Carolina, Oregon, South Carolina, West Virginia, and Wisconsin.

Recordkeeping Problems

In addition to potential state tax problems with increased contributions and certain rollovers, Fidelity pinpoints several other difficult areas. This includes increased recordkeeping and reporting burdens for employers who may be required by the state to track and report non-deductible (for state income tax purposes) amounts contributed to retirement plans

Nonconforming states might pass legislation retroactively adopting the changes contained in the federal Economic Growth and Tax Relief Reconciliation Act of 2001.

Lawmaker to Take Action

One state legislator isn’t wasting any time coming up with a fix. California Assemblyman John Campbell, R-Irvine, a former accountant, calls the failure to reconcile the state and federal tax codes “a disaster waiting to happen.”

Campbell said he will introduce a bill to force California to mirror the 85 changes in federal law. So far, California has adopted one change.

But Campbell’s bill – which would not go into effect until the 2002 tax year at the earliest – will face a tough challenge in the California Capitol.

Adopting the new federal tax-relief provisions would mean about a $100 million loss to the state budget.

That’s one-tenth of one percent of the state budget. But with projections that the state will face a $12.4 billion shortfall next year, lawmakers may find it difficult to part with any amount of cash.

“We will have a very tough fiscal year in 2002-03, so we’ll have to look very closely at any measures that will reduce our revenues,” Sen. Jack Scott, chairman of the Senate Revenue and Taxation committee, told the Orange County Register. If the state adopted the tax incentives “we’d have to make subsequent cuts to state programs to compensate for it.”
California has not conformed with federal tax law since 1998, although most of those changes don’t affect the typical taxpayer.

See the related article on BenefitsLink:

Liberalized Contribution Rules in EGTRRA Could Cause State Income Taxes