Q. I am considering moving to a state with no state income tax upon retirement. Will California demand that I pay income taxes to it on my pension income even after I leave?
A. The completely legal and proper answer is yes. The state of California wants you to pay state income taxes on any pension you receive based on your employment while a resident here. In fact, if your pension comes from a California company, taxes may be withheld before you receive your check.
The practical answer to your question, however, is: It depends. On what? The type of "income" you have after retirement and the state to which you move. Why? Despite California's best efforts at taxing pensions earned here, there are still some ways of getting around what an increasing number of retirees see as a shameless way for the state to grab money.
Here's what some pensioners have done: Those able to take their pensions as lump sum distributions have transferred the funds to a savings institution out of state. By doing so, they put their funds beyond the easy reach of California authorities. To be on the safe side, some also take care not leave any assets or funds in institutions within California, where state authorities can attach them to satisfy tax obligations.
Will this work? It's not supposed to, because if the state finds out about what is, in essence, tax evasion, it will dispatch collection agencies to go after the evaders and attach their out-of-state assets or even sue to recover back taxes.
But the retiree-haven states of Florida and Nevada have taken bold moves. In recent years, both states have passed so-called "shield laws" that refuse to acknowledge liens and judgments against residents of those states who won't pay California income taxes. A spokesman for the California Franchise Tax Board says that although California authorities have not yet mounted a legal challenge to either shield law, they are looking for the "right case" on which to exercise their legal muscle. Meanwhile, he said, the state has yet to notice a "big trend" in pension fund flights to either Nevada or Florida.
By the way, you should know that virtually every state allows its residents a deduction for the state income taxes they pay to California on their pensions, essentially averting a situation of double taxation.
Retirees moving to California should be warned: California will tax your pension even if you earned it elsewhere. However, California will also grant you a tax deduction for state taxes on that same pension paid to another state, again to avert double taxation. In most cases, state Franchise Tax Board authorities say, the state of the retiree's residence grants a deduction for any pension income taxes paid to another state.
Boy's Tax Liability for Fund Capital Gains
Q. I recently sold $3,500 worth of a mutual fund in my 9-year-old son's name. I had purchased the fund about six years ago for $1,500 and had reinvested the dividends and capital gains. Every year, my son's taxable income was less than the $600 that minors are allowed to get tax-free each year. Does he have any tax liability for the $2,000 gain in the value of his fund? --R.F.L.
A. Assuming that you have kept adequate records demonstrating the gradual gain in the value of your son's investment, he should not face any tax consequences from the sale of the mutual fund stake. You will have to file a tax return for your son for the proceeds from the sale. You should show the proceeds on Schedule D. Your tax basis in the investment is its original cost plus your annual reinvestment of the dividends and capital gains. If you want to make doubly sure, attach a note detailing the annual rise in the fund's value to demonstrate why the proceeds are not taxable now because they were accumulated in amounts too low to be taxed in an individual year. Your situation offers a perfect demonstration of the reason accurate record keeping, although annoying, is so important.
401 (k) Rollovers and Income Averaging
Q. Can you give me the direct citation from the Internal Revenue Code that permits taxpayers to roll over a 401(k) plan into a "pure" individual retirement account and later transfer those funds back to another 401(k) or Keogh account in order to take advantage of five- and 10-year income averaging of a lump sum distribution? --K.K.
A. You should look for Internal Revenue Code Sect. 408(d)(3)(A)(ii) for the authority you are seeking. However, be advised that you are required to keep the funds in the second 401(k) or Keogh account for a minimum of five years to qualify for income averaging.
CD Maturity and IRA Requirement
Q. I will soon be required to take a mandatory distribution from my IRA. The problem is that I have an account in a bank certificate of deposit that does not mature until 1998. Will the bank penalize me for making this mandatory withdrawal? --S.Y.
A In all likelihood you will be penalized for withdrawing funds from a CD before it reaches maturity. Your only recourse is to take your distribution from another IRA, if you have one. The IRS does not care from which IRA you take your mandatory distribution; it cares only that you take the required minimum distribution by the appropriate deadline.