1040-NR IRA distributions - state tax

[qxt70]

Is non-resident taxpayer filing 1040-NR subject to state income taxation on qualified IRA distributions?

A long-time client approached me about the tax situation of a relative. The relative will be a non-resident taxpayer (citizen of and domiciled in a foreign country) and has been residing overseas for the past 20+ years. This person had previously worked in US (NY state) and thus has money in a rollover IRA account arising from contributions made while she was working then. She decided it's time to take qualified distributions from this account.

In term of reporting, I understand the part about reporting the original contributions (from earned income) as ECI and the investment earnings portion (capital appreciation, interest and dividends) as FDAP on the 1040-NR. Kindly correct me if I am incorrect.

But,

1) What about state tax? Is the IRA distributions subjected to state income taxation as she is now a non-resident and domiciled overseas and not domiciled in any state in US?

2) She doesn't have the records for her original contributions amount. To figure out the original contribution and the FDAP portions, can we use the "cost basis" from her monthly statements from her IRA plan administration as the amount of her original contributions?

Thanks in advance.

[BobKamman]

4 U.S.C.
§114. Limitation on State income taxation of certain pension income
(a) No State may impose an income tax on any retirement income of an individual who is not a resident or domiciliary of such State (as determined under the laws of such State).

(b) For purposes of this section—

(1) The term "retirement income" means any income from—
. . .
(E) an individual retirement plan described in section 7701(a)(37) of such Code;

[qbteachmt]

2. All withdrawals from a traditional IRA are ordinary taxable income, unless there is post-tax contribution (which form Basis). It doesn't matter what "cost basis" is for internal investments in an IRA. There is no gain or loss. There is only the amount taken and it will be income. Even if the reported basis is her contributions, it's moot unless something was post-tax.

[BobKamman]

Form 1040-NR does have some instructions about allocating pensions between earned income and investment income.  But it seems to be based on when the employment occurred, and 1986 was a relatively long time ago.  Where did you find something more specific?

If you worked in the United States
after December 31, 1986, the part of
each pension distribution that is
attributable to the services you
performed after 1986 is income that is
effectively connected with a U.S.
trade or business.
Example. You worked in the
United States from January 1, 1980,
through December 31, 1989 (10
years). You now receive monthly
pension payments from your former
U.S. employer's pension plan. 70% of
each payment is attributable to
services you performed during 1980
through 1986 (7 years) and 30% of
each payment is attributable to
services you performed during 1987
through 1989 (3 years). Include 30%
of each pension payment in the total
amount that you report on line 5a.
Include 70% of each payment in the
total amount that you report in the
appropriate column on Schedule NEC
(Form 1040-NR), line 7.

[qxt70]

@BobKammanThanks, Bob. The code section you cited is most helpful. Exactly what I needed.

[qbteachmt]

I thought the account is an IRA (defined contribution). A pension is a defined benefit. Not the same.

[qxt70]

@qbteachmtThanks. Your comments helped greatly. That's what I thinking too, after initially reading the instructions to 1040-NR line 4a and 4b (IRA Distributions), which instructed "See Lines 4a and 4b - IRA Distributions in the instructions for Form 1040 for details on IRA distributions." Treat it as ordinary taxable income.

Then, perhaps unfortunately, I came across an online article about tax treatment for IRA Distributions for non-resident filing 1040-NR that talked about the bifurcation treatment of IRA Distributions on 1040-NR into 2 separate parts: (1) "Original contribution" - treated as ECI up to the amount of contributions to the IRA and taxed at the regular graduated tax rates; & (2) "Investment earnings" - treated as passive income and at the unfavorable flat rate of 30%.  That what confused me, hence me coming over to this community to see how others here are reporting the IRA distributions on 1040-NR for their clients.

Here is the link to the article: https://hodgen.com/ira-distributions-for-noncovered-expatriates/

[qxt70]

Yes, it's an IRA account. I had thought "(E) an individual retirement plan described in section 7701(a)(37) of such Code" would covers IRAs?

[qxt70]

@BobKammanIt's an IRA account. Please see my earlier reply to qbteachmt regarding my confusion about the tax treatment due to an online article I read.

[BobKamman]

The problem with that article is that it seems to rely on a 1979 Revenue Ruling, and the 1040-NR instructions indicate that there was a change in law in 1986 (probably the Tax Reform Act of that year) that changed everything.  I find it odd that articles written since 1986 that refer to RR 79-388 do not mention any change from 1986.  You might contact the author of the article you cite, and ask what happened.  

[BobKamman]

@qxt70 Note that it's not Internal Revenue Code (Title 26). It's in Title 4. 

[qxt70]

You raised good points. Appreciate greatly your replies. Thanks.