COLORADO DEPARTMENT OF REVENUE
STATEMENT OF BASIS AND PURPOSE
Pension and Annuity Income
39-22-104(4)(f)
1 CCR 201-2
Basis
The basis for this rule is §39-21-112(1) and §39-22-104(4)(f), C.R.S.
Purpose
The Department has clarified the regulation to make clear that the pension and annuity benefit subtraction generally applies only if payments are periodic, arise from personal services performed prior to the taxpayer’s retirement, and are paid after such retirement. The legislative history makes clear that these requirements apply to benefits derived from sources described in subsections (1)(a)(i)-(iii). In 1988, the legislature amended subsection 104 in a manner that suggests that the term “periodic payments” and “attributable to personal services performed by an individual prior to his or her retirement” were intended to modify all three sources of “pensions and annuities” (i.e., sources listed in paragraph 1(a)(i)-(iii). The language was specifically modified under House Bill No. 1201 as follows:
For the purposes of this paragraph (f), “pensions and annuities” means retirement benefits which are periodic payments attributable to personal services performed by an individual prior to his retirement from employment and which arise from an employer-employee relationship, FROM service in the uniformed services of the United States, or from contributions to a retirement plan which are deductible for federal income tax purposes.
1988 Colo. Sess. Laws., ch. 273, p. 1312 (emphasis in original).
We note that at the time that this amendment was made, the New York Tax Code had adopted an approach substantially similar to the one proposed in this regulation. Indeed, the New York Code may have been the source of the language used by the Colorado General Assembly in 1987 to amend the Colorado pensions and annuity subtraction. Specifically, in 1987, and dating back to 1981, New York law provided a subtraction from taxable income of:
Pensions and annuities received by an individual who has attained the age of fifty-nine and one-half, not otherwise excluded pursuant to paragraph three of this subsection, to the extent includible in gross income for federal income tax purposes, but not in excess of twenty thousand dollars, which are periodic payments attributable to personal services performed by such individual prior to his retirement from employment, which arise (i) from an employer-employee relationship or (ii) from contributions to a retirement plan which are deductible for federal income tax purposes.
1992 New York Sess. Laws. Ch. 1043, p. 2703 (emphasis added). As evidenced by the legislature’s use of subheadings (i) and (ii), the phrase “periodic payments attributable to personal services performed by such individual prior to his retirement from employment” modifies both employer-employee sourced benefits and other retirement plan related benefits under New York law. The New York statute further confirms that “periodic payments attributable to personal services” is intended to function as the general, substantive rule by following that rule with express exceptions as follows:
However, the term ‘pensions and annuities’ shall also include distributions received by an individual who has attained the age of fifty-nine and one-half from an individual retirement account or an individual retirement annuity, as defined in [IRC § 408], and distributions received by an individual who has attained the age of fifty-nine and one-half from self-employed individual and owner-employee retirement plans which qualify under [IRC § 401], whether or not the payments are periodic in nature. Nevertheless, the term ‘pensions and annuities’ shall not include lump sum distributions, as defined in [IRC § 402(e)(4)(A)] and taxed under section [601-C] of this article.
1992 New York Sess. Laws. Ch. 1043, p. 2703 (emphasis added). It appears the Colorado legislature similarly provided certain express exceptions to the general rule requiring periodic payments in the fourth sentence of section 39-22-104(4)(f)(III), C.R.S. Such express exceptions would have been unnecessary if the “periodic payments attributable to personal services” language was merely illustrative and not intended to be given substantive effect. The underlying regulatory provision promulgated by New York’s Department of Taxation and Finance provides further support for the conclusion that “periodic payments” and “personal services” are both substantive requirements. Among other things, the regulation provides for the subtraction to be taken only if certain conditions are met, including:
(a) the pension and annuity income must be included in Federal adjusted gross income;
(b) the pension and annuity income must be received in periodic payments (unless otherwise provided in this paragraph);
(c) the pension and annuity income must be attributable to personal services performed by such individual, prior to such individuals retirement from employment, which arises from either an employer-employee relationship or from contributions to a retirement place which are tax deductible under the Internal Revenue Code (e.g., individual retirement account (IRA) or self-employed retirement (Keogh)); and
(d) such individual receiving the pension and annuity income must be 59 1⁄2 years of age or over.
N.Y. Comp. Codes R. & Regs. tit. § 112.3(c)(2) (emphasis added).
For these reasons, this regulation makes clear that “periodic payments” derived from “personal services prior to retirement” and “paid after retirement” are qualifications that apply to all three sources identified in subsections (1)(a)(i)-(iii).
The statute does not define ‘periodic’. The Department generally looks to the Internal Revenue Code to provide definition of terms that are not defined in state statute. The Department adopts the definition of periodic payment set forth in Internal Revenue Service publication 939 (General Rules for Pension and Annuities).
In addition to stating a general rule for identifying pension and annuity benefits that qualify for the subtraction, the legislature identified in section 39-22-104(4)(f)(III), C.R.S. specific benefits that qualify for the subtraction, even though they do not meet one or more of the qualifications set forth in the general rule. For example, a lump-sum distribution would not constitute periodic payments. Nevertheless, the legislature elected to allow a lump-sum payment to be eligible for the subtraction (but see discussion below regarding federal amendments to I.R.C. §402).
The Department listed several types of pension or annuity benefits that qualify for the subtraction if the general rule and limitations under paragraphs (1) and (2) are met. For example, distributions from a section 457 plan can qualify for the subtraction because these plans typically fall within either subparagraph 1(a)(i) or (iii), even though these are arguably not “retirement plans” because a taxpayer can, for federal tax purposes, receive distributions from a 457 plan prior to the minimum retirement age without incurring a penalty. Notwithstanding this arguable point, the Department included these plans if they otherwise meet the qualifications and limitations of paragraphs (1) and (2) because the legislative history indicates that the legislature intended to apply broadly the subtraction. However, the reference to the many plans listed in paragraph (3) does not mean that all distributions from these plans can be included in the subtraction. Distributions must meet the qualifications and limitations of paragraphs (1) and (2). For example, although distributions from a 457 plan qualify for the subtraction, a lump-sum distribution from such plan or periodic distributions from a 457 plan prior to retirement do not qualify for the subtraction.
The limitation regarding premature distributions applies only to individual retirement arrangements (IRAs) and self-employed retirement accounts. The statute does not define ‘premature distribution’, but the term is used in the federal income tax code. Therefore, the Department will use the federal definition of premature distribution for purposes of this state statute. In general, a distribution is premature for federal tax purposes if it is subject to federal income tax penalty (sometimes referred to as additional tax), which is generally described in I.R.C. § 72(t). Some premature distributions are not subject to this additional tax (e.g., distributions for hardship) and, therefore, are not excluded from the subtraction as a premature distribution.
The Department eliminated the reference to retirement income defined in 4 U.S.C. §144(1)(b)(I) because such income is not reported as federal taxable income and, therefore, the subtraction does not apply.
The regulation was amended to clarify how the $20,000 and $24,000 limitations applies to individuals who are beneficiaries of a deceased person who was originally entitled to pension or annuity benefits that qualified for the subtraction. The Department concluded that the interpretation most consistent with the statutory language is to apply the $20,000 limitation to a beneficiary who is less than 65 years of age, even if the beneficiary is less than 55 years of age, and the $24,000 limitation to a beneficiary at least 65 years old.
The regulations clarifies that trusts and estates are not entitled to the subtraction because §39-22-104(4)(f), C.R.S refers only to “individuals”.
Railroad retirement benefits are generally grouped into Tier I and Tier II benefits. The regulation was expanded to make clear that railroad retirement annuity benefits includes annuity benefits to a spouse, divorced spouse and survivors (e.g., children of railroad employees) and supplemental railroad retirement annuity benefits.
The Department expanded the list of payments that do not qualify for the subtraction. To this list the Department added lump-sum payments that were previously eligible pursuant to section 39-22-104(4)(f(III), C.R.S. Prior to 1992, lump-sum distributions that were subject to the income tax averaging provisions of I.R.C. §402(e)(1), qualified for the subtraction if the deduction for such distributions, authorized by I.R.C. §402(e)(3), were added to Colorado taxable income pursuant to section §39-22-104(3)(c), C.R.S. In 1992, Congress rewrote §402(a) through (f) (Public Law 102-318, sec. 511) to move these provisions to other sections in §402 and, in 1996 (Public Law 104-188), completely eliminated the provisions for income tax averaging and the deduction for lump-sum distributions.