By: Gary Hirsh, CPA, CFP®
Did you know that a percentage of your IRA distributions may not be subject to New Jersey state taxation? There are two possible exclusions for IRA distributions from New Jersey income taxes.
2 Possible Exclusions for IRA Distributions from New Jersey Income Taxes
The exclusion of IRA distributions from your New Jersey income under the state's pension exclusion. You need to be age 62 or older and have a total income of less than $100,000. The exclusion is $100,000 for married couples and $75,000 for singles if you qualify.
Taxpayers who earn between $100,000 and $150,000 receive a partial exclusion. Married couples who file a joint tax return and have a gross income of between $100,000 and $125,000 would be able to exclude 50% of their payments from income. Married couples who earn a higher amount, between $125,000 and $150,000, would be able to exclude 25% of payments.
Single taxpayers exclude 37.5% of payments if they earn between $100,000 and $125,000, while singles who earn between $125,000 and $150,000 would exclude 18.75% of payments.
But what if your income in retirement is greater than $150,000?
Since New Jersey does not allow IRA deductions while funding your IRA, the amount you contributed is not taxed when you withdraw your IRA.
Furthermore, many New Jersey self-employed or partners in partnerships have contributed significant amounts to SEP IRA's or funded 401K accounts more than the annual maximum allowed by the state. Those distributions may qualify for exemption from New Jersey tax. This also applies to defined benefit plans.
For example, the 2021 maximum allowed was $19,500 for residents under age 50 and $26,000 for those over age 50. Amounts deducted for federal purposes over these amounts were not allowed as a state deduction. As a result, they are not taxed on withdrawal. This is referred to as having a "basis" in your IRA and is eligible for an exclusion ratio against New Jersey income tax.
Here is a real-life example. In 2021 a client had an RMD of $183,000 based on an IRA value of $5 million. Most of the account had been rolled over from their partnership 401K plan. A review of the client's Federal vs. NJ returns for the past 13 years revealed that the client had, in the aggregate, deducted $1 million on their federal return while $500K was deducted for NJ. For New Jersey taxes, $4.5 million of the account was deemed earnings ($5 million value less $500K deducted for New Jersey). The amount of earnings excluded was 10% ($500,000 previously taxed divided by the $5 million value of the IRA.)
The exclusion reduced the NJ taxable distribution by $18,300 (10% of the $183,000 withdrawal). The client's tax rate was 8.97%, and the tax savings was $1,642. Depending on the success of the investments, I have seen as much as 20% of an IRA distributed excluded from NJ tax.
Proper treatment of these "state excess contributions" requires a review of past returns to ascertain the difference between the federal and state amounts deducted every year. Often an issue is that these records are not available.
If you are a New Jersey resident and plan to retire in New Jersey, you should keep good records of any deductible IRA contributions. You should also keep records if you are a partner or sole proprietor of a business and make annual contributions greater than the 401(k) salary deferral amount.