Up-to-the-minute advice, information, resources, and, on occasion, commentary on federal and New Jersey state income taxes, and the various New Jersey property tax rebate programs, and insights and observations on tax policy and professional tax practice, by 40-year veteran tax professional Robert D Flach.
Friday, April 27, 2012
WHAT THE CPA MISSED
Several readers of my post “A Tax Season Story” have asked me what the CPA missed that would generate such a
large tax liability.
While the IRS has not used the “Three
Year Method” for recovering after-tax employee contributions to a pension plan
for decades, the State of NJ still does.
The instructions for the NJ-1040
tells us - “if you will recover your
contributions within three years from the date you receive the first payment
from the plan, and both you and your employer contributed to the plan, you may
use the Three-Year Rule Method to determine your taxable pension income”.
Under this method you “exclude your pension and annuity payments
from gross income until the payments you receive equal your contributions to
the plan.Until that time, the amounts
you receive, because they are considered your contributions, are not taxable and
should not be reported on your return.”
The taxpayer in the situation had
begun to receive his pension from the NJ Division of Pensions in late 2010.While his after-tax employee contributions
are amortized over an expected life on the federal return, the taxpayer qualified
for contribution recovery under the Three-Year Rule Method on his NJ-1040.
NJ will only treat employee
contributions to a 401(k) plan as pre-tax for state income tax purposes.Because the pension plan from which the
taxpayer was receiving distributions was a 403(b) plan all employee
contributions to the plan were treated as “after tax” for NJ purposes. NJ state wages were never reduced by the
The CPA reported on the preliminary 2011
NJ-1040 the same amount of pension income that was reported on the federal Form
1040.This would have resulted in an
excessive overpayment.The taxpayer was
still working (not for the State of NJ) and his spouse also did, with a much
higher salary, so the exempt pension distribution would have been taxed at a
very high rate.
Included in the taxpayer’s copy of
his 2010 NJ-1040 was a statement from me that indicated his total after-tax
contributions, the amount recovered in 2010, and the carryforward to 2011.The taxpayer provided the CPA was the copies
of his 2010 federal and state returns.
A very expensive mistake!
FYI – the offices of the CPA were in
NJ and not NY.