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109th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 2d Session                                                     109-542

======================================================================



 
                  STATE TAXATION OF RETIREMENT INCOME

                                _______
                                

 June 29, 2006.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

 Mr. Sensenbrenner, from the Committee on the Judiciary, submitted the 
                               following

                              R E P O R T

                        [To accompany H.R. 4019]

      [Including cost estimate of the Congressional Budget Office]

  The Committee on the Judiciary, to whom was referred the bill 
(H.R. 4019) to amend title 4 of the United States Code to 
clarify the treatment of self-employment for purposes of the 
limitation on State taxation of retirement income, having 
considered the same, report favorably thereon with an amendment 
and recommend that the bill as amended do pass.

                                CONTENTS

                                                                   Page
The Amendment....................................................     1
Purpose and Summary..............................................     2
Background and Need for the Legislation..........................     2
Hearings.........................................................     3
Committee Consideration..........................................     3
Vote of the Committee............................................     4
Committee Oversight Findings.....................................     4
New Budget Authority and Tax Expenditures........................     4
Congressional Budget Office Cost Estimate........................     4
Performance Goals and Objectives.................................     5
Constitutional Authority Statement...............................     6
Section-by-Section Analysis and Discussion.......................     6
Changes in Existing Law Made by the Bill, as Reported............     6
Markup Transcript................................................     7

                             The Amendment

  The amendment is as follows:
  Strike all after the enacting clause and insert the 
following:

SECTION 1. CLARIFICATION OF TREATMENT OF SELF-EMPLOYMENT FOR PURPOSES 
                    OF THE LIMITATION ON STATE TAXATION OF RETIREMENT 
                    INCOME.

  (a) In General.--Section 114(b)(1)(I) of title 4, United States Code, 
is amended--
          (1) by inserting ``(or any plan, program, or arrangement that 
        is in writing, that provides for retirement payments in 
        recognition of prior service to be made to a retired partner, 
        and that is in effect immediately before retirement begins)'' 
        after ``section 3121(v)(2)(C) of such Code'',
          (2) by inserting ``which may include income described in 
        subparagraphs (A) through (H)'' after ``(not less frequently 
        than annually'',
          (3) by adding at the end the following:
                  ``The fact that payments may be adjusted from time to 
                time pursuant to such plan, program, or arrangement to 
                limit total disbursements under a predetermined 
                formula, or to provide cost of living or similar 
                adjustments, will not cause the periodic payments 
                provided under such plan, program, or arrangement to 
                fail the `substantially equal periodic payments' 
                test.'', and
          (4) by adding at the end the following:
          ``(4) For purposes of this section, the term `retired 
        partner' is an individual who is described as a partner in 
        section 7701(a)(2) of the Internal Revenue Code of 1986 and who 
        is retired under such individual's partnership agreement.''.
  (b) Application.--The amendments made by this section apply to 
amounts received after December 31, 1995.

                          Purpose and Summary

    H.R. 4019 makes technical and clarifying amendments to 
section 114 of title 4 of the United States Code.

                Background and Need for the Legislation

    H.R. 4019 makes technical and clarifying amendments to 
section 114 of title 4 of the United States Code, which was 
enacted in 1996 to restrict the ability of States to tax 
certain types of pension income received by their former 
residents and nonresidents who earned income in that State.\1\ 
Section 114 exempts from non-resident taxation certain income 
received from ``qualified'' pension plans (as defined in the 
Internal Revenue Code) as well as income received under certain 
``non-qualified'' retirement plans, including liquidation 
payments paid out of current year profits to retiring partners 
in a service partnership. Specifically, section 114(a) 
prohibits a State from taxing ``retirement income'' of its 
former residents or nonresidents who earned income within the 
State, including income from a nonqualified deferred 
compensation plan, provided it is part of a series of 
substantially equal periodic payments made (not less frequently 
than annually) over the life expectancy of the recipient, or 
for a period of not less than 10 years. Section 114(b)(1)(I) 
defines nonqualified deferred compensation plans by reference 
to section 3121(v)(2)(C) of the Internal Revenue Code, which 
relates to employment taxes.\2\
---------------------------------------------------------------------------
    \1\Pub. L. No. 104-95, 109 Stat. 979 (codified at 4 U.S.C. Sec. 114 
(2002)).
    \2\26 U.S.C. Sec. 3121(v)(2)(C) (2002).
---------------------------------------------------------------------------
    Questions have arisen as to whether section 114 was 
intended to apply to nonqualified retirement income paid by a 
partnership to its retired nonresident partners (including 
retired partner equivalents, e.g., retired principals). The 
reference to section 3121(v)(2)(C) is definitional with regard 
to nonqualified deferred compensation income, irrespective of 
whether the recipient was subject to the Federal Insurance 
Contribution Act (``FICA'') tax. Nevertheless, the provision's 
incorporation of the Internal Revenue Code's definition of 
``nonqualified deferred compensation plans'' has been construed 
by at least one State to limit the exemption to payments made 
only to retired employees (i.e., those individuals subjected to 
FICA tax), as section 3121(v)(2)(C) is written in the context 
of employment taxation and there is no specific reference to 
retired partners in section 114 of title 4 of the United States 
or in section 3121(v)(2)(C) of the Internal Revenue Code.
    On October 7, 2005, Representative Cannon (R-UT) introduced 
H.R. 4019 to clarify that this exemption applies to both 
retired employees and retired partners by specifically 
including written plans or arrangements for retired partners. A 
retired partner is defined as a person who is described as a 
partner in Internal Revenue Code Section 7701(a)(2) and who is 
retired under the person's partnership agreement. The bill 
makes clear that any written plan, program, or arrangement in 
effect at the time of retirement that provides for payments to 
a retired partner in recognition of prior service may qualify 
as exempt from nonresident State income taxation as long as 
such payments are made over 10 years or more and are made in 
substantially equal periodic payments.
    H.R. 4019 also clarifies the definition of substantially 
equal periodic payments to permit plan caps on retiree payments 
and cost of living adjustments (COLAs), and clarifies that the 
substantially equal periodic payments test is satisfied when 
payments include components from both qualified and 
nonqualified plans. These modifications are intended to clarify 
existing law rather than substantively amend it.
    H.R. 4019 is intended to make clear Congress's original 
intent when it passed section 114, i.e. to limit the taxation 
of retirement income to the State in which the retiree resides, 
whether the retirement payments are made to a retired employee 
or a retired partner. H.R. 4019 merely confirms and continues 
this Congressional intent.

                                Hearings

    The House Committee on the Judiciary's Subcommittee on 
Commercial and Administrative Law held a hearing on H.R. 4019 
on December 13, 2005. Testimony was received from the following 
witnesses: the Honorable George W. Gekas, former United States 
Representative and former Chairman of the Subcommittee on 
Commercial and Administrative Law; Lawrence F. Portnoy, retired 
partner, PricewaterhouseCoopers LLP; Harley T. Duncan, 
Executive Director, Federation of Tax Administrators; and 
Stanley R. Arnold, CPA, former Commissioner of New Hampshire's 
Department of Revenue Administration and former President of 
the Federation of Tax Administrators.

                        Committee Consideration

    On December 13, 2005, the Subcommittee on Commercial and 
Administrative law met in open session and ordered favorably 
reported the bill, H.R. 4019, by voice vote, a quorum being 
present. On June 7, 2006, the full Committee met in open 
session and ordered favorably reported the bill, H.R. 4019, as 
amended, by voice vote, a quorum being present.

                         Vote of the Committee

    In compliance with clause 3(b) of rule XIII of the Rules of 
the House of Representatives, the Committee notes that there 
were no recorded votes during the Committee consideration of 
H.R. 4019.

                      Committee Oversight Findings

    In compliance with clause 3(c)(1) of rule XIII of the Rules 
of the House of Representatives, the Committee reports that the 
findings and recommendations of the Committee, based on 
oversight activities under clause 2(b)(1) of rule X of the 
Rules of the House of Representatives, are incorporated in the 
descriptive portions of this report.

               New Budget Authority and Tax Expenditures

    Clause 3(c)(2) of rule XIII of the Rules of the House of 
Representatives is inapplicable because this legislation does 
not provide new budgetary authority or increased tax 
expenditures.

               Congressional Budget Office Cost Estimate

    In compliance with clause 3(c)(3) of rule XIII of the Rules 
of the House of Representatives, the Committee sets forth, with 
respect to the bill, H.R. 4019, the following estimate and 
comparison prepared by the Director of the Congressional Budget 
office under section 402 of the Congressional Budget Act of 
1974:

                                     U.S. Congress,
                               Congressional Budget Office,
                                     Washington, DC, June 22, 2006.
Hon. F. James Sensenbrenner, Jr.,
Chairman, Committee on the Judiciary,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 4019, a bill to 
amend title 4 of the United States Code to clarify the 
treatment of self-employment for purposes of the limitation on 
State taxation of retirement income.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Sarah Puro.
            Sincerely,
                                          Donald B. Marron,
                                                   Acting Director.

    Enclosure.

H.R. 4019--A bill to amend title 4 of the United States Code to clarify 
        the treatment of self-employment for purposes of the limitation 
        on State taxation of retirement income
    H.R. 4019 would amend current law (Public Law 104-95) to 
prohibit State taxation of certain retirement income of former 
residents. The legislation would specifically limit the ability 
of States to tax the retirement income of nonresidents who were 
partners in firms domiciled within a State. These provisions 
could result in some individuals having lower itemized 
deductions of State income taxes on their federal income tax 
returns and, therefore, higher federal income taxes. Under the 
assumption that, in the absence of this legislation, States 
would continue to tax certain retirement income of former 
residents, CBO estimates that enacting this bill would result 
in an increase in federal income taxes of less than $500,000 
per year, totaling about $1 million over the 2007-2016 period. 
CBO estimates that H.R. 4019 would have no significant impact 
on federal spending.
    The prohibition on taxing the income of certain retirees 
would constitute an intergovernmental mandate as defined in the 
Unfunded Mandates Reform Act (UMRA) because it would preempt 
the authority of States to tax. Since UMRA includes in its 
definition of the direct costs of a mandate amounts that State 
and local governments would be prohibited from raising in 
revenues, the cost of this mandate would include the amounts 
that States are currently collecting but would be precluded 
from collecting under H.R. 4019. Based on information from the 
States and some of the affected partnerships, CBO estimates 
that the net costs to State governments would likely total less 
than $5 million annually and thus would not exceed the 
threshold established in UMRA ($64 million in 2006, adjusted 
annually for inflation) in any of the first five years after 
enactment.
    Under current law, there is some uncertainty as to the 
taxability of the income of retired partners who do not 
currently live in the State where they initially earned that 
income. Only one State, New York, has issued rules that require 
retired partners to pay such taxes, and those rules are 
currently being challenged in court. At least 15 other States 
report that they currently collect tax on such revenues 
although they are not actively auditing or pursuing partners or 
companies who are not remitting these taxes. It is unclear if 
other States currently collect such tax or would do so in the 
next five years in the absence of legislation.
    In total, CBO estimates that actual State tax collections 
that would be affected by this legislation total less than $10 
million annually. Many retired partners who pay taxes to States 
where they do not currently live receive credit for those taxes 
in the State where they do live. Such credits would partially 
offset these losses, resulting in a net impact across all 
States totaling less than $5 million annually.
    The bill contains no private-sector mandates as defined in 
UMRA.
    The CBO staff contacts for this estimate are Barbara 
Edwards (for federal revenues) and Sarah Puro (for the State 
and local impact). This estimate was approved by Peter H. 
Fontaine, Deputy Assistant Director for Budget Analysis, and G. 
Thomas Woodward, Assistant Director for Tax Analysis.

                    Performance Goals and Objectives

    The Committee states, pursuant to clause 3(c)(4) of rule 
XIII of the Rules of the House of Representatives, that H.R. 
4019 will clarify treatment of self-employment for purposes of 
the limitation on State taxation of retirement income.

                   Constitutional Authority Statement

    Pursuant to clause 3(d)(1) of rule XIII of the Rules of the 
House of Representatives, the Committee finds the authority for 
this legislation in art. I, Sec. 8, cl. 8 of the Constitution.

               Section-by-Section Analysis and Discussion

    The following discussion describes the bill as reported by 
the Committee.
Sec. 1. Clarification of treatment of self-employment for purposes of 
        the limitation on State taxation of retirement income
    Subsection 1(a) of H.R. 4019 amends section 114 of title 4 
of the United States Code to clarify that States may not impose 
an income tax on non-resident retirement income received under 
certain nonqualified deferred compensation plans, including 
written plans, in effect at the time of retirement, providing 
for payments to a retired partner (as defined in subsection 
1(a)) in recognition of prior service, as long as such payments 
are made over 10 years or more, and are made in substantially 
equal periodic payments.
    Subsection 1(a) of H.R. 4019 also amends section 114 to 
permit benefit reductions pursuant to a predetermined formula 
capping total disbursements, or benefit adjustments pursuant to 
plan provisions providing COLA adjustments, without causing the 
periodic benefits provided under the plan to fail the 
``substantially equal periodic payments'' test. For example, in 
order to manage retirement costs, a company might limit 
aggregate payments to retirees to a certain percentage of its 
annual income such that benefit reductions would be required if 
this cap is reached. Subsection 1(a) of H.R. 4019 amends 
section 114 to clarify that the substantially equal periodic 
payments test is satisfied when payments include components 
from both qualified and nonqualified plans. For example, under 
a pre-determined plan formula, the total annual payments to a 
retiree may remain the same from year to year, but the payments 
may be required to come first from a Keogh plan (i.e., 
qualified plan) until depleted and then from the general assets 
of the business (i.e., nonqualified plan).
    Subsection (1)(b) specifies that the amendment applies to 
amounts received after December 31, 1995. For open years, 
refunds or credits would be available to the extent allowed 
under applicable state law.

         Changes in Existing Law Made by the Bill, as Reported

  In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (new matter is 
printed in italic and existing law in which no change is 
proposed is shown in roman):

               SECTION 114 OF TITLE 4, UNITED STATES CODE

Sec. 114. Limitation on State income taxation of certain pension income

  (a)  * * *
  (b) For purposes of this section--
          (1) The term ``retirement income'' means any income 
        from--
                  (A)  * * *

           *       *       *       *       *       *       *

                                  (I) any plan, program, or 
                                arrangement described in 
                                section 3121(v)(2)(C) of such 
                                Code (or any plan, program, or 
                                arrangement that is in writing, 
                                that provides for retirement 
                                payments in recognition of 
                                prior service to be made to a 
                                retired partner, and that is in 
                                effect immediately before 
                                retirement begins), if such 
                                income--
                          (i) is part of a series of 
                        substantially equal periodic payments 
                        (not less frequently than annually 
                        which may include income described in 
                        subparagraphs (A) through (H)) made 
                        for--
                                  (I)  * * *

           *       *       *       *       *       *       *

        Such term includes any retired or retainer pay of a 
        member or former member of a uniform service computed 
        under chapter 71 of title 10, United States Code. The 
        fact that payments may be adjusted from time to time 
        pursuant to such plan, program, or arrangement to limit 
        total disbursements under a predetermined formula, or 
        to provide cost of living or similar adjustments, will 
        not cause the periodic payments provided under such 
        plan, program, or arrangement to fail the 
        ``substantially equal periodic payments'' test.

           *       *       *       *       *       *       *

          (4) For purposes of this section, the term ``retired 
        partner'' is an individual who is described as a 
        partner in section 7701(a)(2) of the Internal Revenue 
        Code of 1986 and who is retired under such individual's 
        partnership agreement.

           *       *       *       *       *       *       *


                           Markup Transcript



                            BUSINESS MEETING

                        WEDNESDAY, JUNE 7, 2006

                  House of Representatives,
                                Committee on the Judiciary,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 1:10 p.m., in 
Room 2141, Rayburn House Office Building, the Honorable F. 
James Sensenbrenner, Jr. (Chairman of the Committee) presiding.
    [Intervening business.]
    Chairman Sensenbrenner. The next item on the agenda is the 
adoption of H.R. 4019 to amend title 4 of the United States 
Code to clarify the treatment of self-employment for purposes 
of the limitation of State taxation on retirement income.
    The Chair recognizes the gentleman from Utah, Mr. Cannon, 
the Chairman of the Subcommittee on Commercial and 
Administrative Law for a motion.
    Mr. Cannon. Thank you, Mr. Chairman. The Subcommittee on 
Commercial and Administrative Law reports favorably the bill 
H.R. 4019 and moves its favorable recommendation to the full 
House.
    [The bill, H.R. 4019, follows:]
    
    
    Chairman Sensenbrenner. Without objection, H.R. 4019 will 
be considered as read and open for amendment at any point. The 
Chair recognizes Mr. Cannon to strike the last word, and 
recognizes him for 5 minutes.
    Mr. Cannon. I thank the Chairman.
    H.R. 4019 is a technical amendment to Public Law 104-95. 
This legislation clarifies that all retirees should be treated 
the same with regard to how States may tax retirement payments.
    In 1996, Congress passed Public Law 104-95 to prohibit 
States from taxing the retirement income of nonresident 
retirees. Essentially, when retirees, most of whom are on fixed 
incomes, are not living in the State, then no State except the 
State where the individual resides should tax the retiree's 
income.
    After passage of the 1996 law, most States interpreted the 
law as it was intended to apply to all retirees, including 
employees and partners. One State, however, has recently taken 
the position that it can treat retired employees of a company 
and retired partners from partnerships differently.
    The State's interpretation is contrary to the original 
intent of the law and would allow for a State to tax retirement 
payments of a person who retires from a partnership no matter 
where the retiree is living. This was not the intent of 
Congress when the bill was passed, as was emphasized at our 
hearing by our former colleague, who was chair of the 
Subcommittee when Public Law 104-95 was enacted. Congress 
intended for all retirees to be treated the same under the law, 
and H.R. 4019 simply clarifies that intent. States must treat 
all retirees similarly.
    I worked with the State tax administrators to craft a 
manager's amendment to alleviate some of their initial 
concerns, and I appreciate their efforts in coming to the table 
to reach an agreement.
    I urge all of my colleagues to support H.R. 4019 and I 
yield back.
    Chairman Sensenbrenner. In the absence of the gentleman 
from North Carolina, the gentleman from Michigan is recognized 
for 5 minutes for an opening statement.
    Mr. Conyers. Thank you, Mr. Chairman. I appreciate the work 
of the Subcommittee Chairman, and I speak on behalf of the 
gentleman from North Carolina, Mr. Watt.
    We do not oppose H.R. 4019, which is intended to clarify 
Public Law 104-95 by prohibiting States from taxing the 
retirement income of any nonresident whether the individual is 
a retired employee, partner or principal, and that benefit 
reduction calculations under the bill include components from 
both qualified and nonqualified plans.
    One thing that I had originally opposed has been corrected. 
Since 1996, States have adjusted their tax system to reflect 
the policy, and to allow several different interpretations of 
the policy would upset expectations and reliance on the law and 
would further confuse the tax system and certainly lead to 
litigation.
    This clarification is a needed measure to protect the 
current State taxation policies, and I urge my colleagues not 
to oppose it and to support the measure and I ask unanimous 
consent to include my further statement in the record.
    Chairman Sensenbrenner. Without objection, so ordered.
    Without objection, all Members may introduce opening 
statements into the record at this point.
    The Chair recognizes the gentleman from Utah, Mr. Cannon, 
to offer an amendment in the nature of a substitute.
    Mr. Cannon. Thank you, Mr. Chairman. I have an amendment in 
the nature of a substitute at the desk.
    [The amendment follows:]
    
    
    Chairman Sensenbrenner. The Clerk will report the 
amendment.
    The Clerk. Amendment in the nature of a substitute to H.R. 
4019, offered by Mr. Cannon. Strike all after the enacting 
clause and insert the following----
    Chairman Sensenbrenner. Without objection, the amendment in 
the nature of a substitute is considered as read and open for 
amendment at any point, and the Chair recognizes the gentleman 
from Utah, Mr. Cannon, for 5 brief minutes.
    Mr. Cannon. Thank you, Mr. Chairman. If you can speed up 
your clock, I think I can still beat it.
    This amendment perfects the underlying legislation during 
the hearing on H.R. 4019 held by the Subcommittee on Commercial 
and Administrative Law. Mr. Harley Duncan from the Federation 
of Tax Administrators had a few reservations and some 
suggestions which we have incorporated so that the bill would 
clarify the language of Public Law 104-95 and not extend the 
1996 law into new areas.
    This amendment refines the language of the bill to 
correspond to the current statute in a manner acceptable to all 
interested parties. I urge my colleagues to support this 
amendment and I yield back the many minutes that remain of my 
time.
    Chairman Sensenbrenner. Are there any second degree 
amendments to the amendment in the nature of a substitute?
    For what purpose does the gentleman from Michigan seek 
recognition?
    Mr. Conyers. To strike the requisite number of words.
    Chairman Sensenbrenner. The gentleman is recognized for 5 
minutes.
    Mr. Conyers. I am pleased to rise in support of the 
amendment in the nature of a substitute offered by our 
colleague, Mr. Cannon, and comment favorably as well on the 
remarks of Mr. Harley Duncan.
    This amendment in the nature of a substitute reflects those 
definitions that have been referred to and fully complies with 
the intent of the Federation of Tax Administrators' suggestion. 
And so I think we on this side have no objection to this 
substitute and urge its passage.
    And I return the time.
    Chairman Sensenbrenner. Are there any second degree 
amendments to the amendment in the nature of a substitute 
offered by the gentleman from Utah?
    If there are none, the question occurs on the amendment in 
the nature of a substitute offered by the gentleman from Utah, 
Mr. Cannon. Those in favor will say aye.
    Opposed, no.
    The ayes appear to have it. The ayes have it. The amendment 
in the nature of a substitute is agreed to.
    A reporting quorum is not present. Without objection, the 
previous question is ordered on the motion to report H.R. 4019 
favorably as amended.
    [Intervening business.]
    Chairman Sensenbrenner.The unfinished business is the 
motion to report the bill H.R. 4019 favorably, as amended, on 
which the previous question has been ordered. A reporting 
quorum is present.
    All those in favor, signify by saying aye.
    Opposed, no.
    The ayes appear to have it. The ayes have it. The motion to 
report the bill favorably, as amended, is agreed to.
    Without objection, the bill will be reported favorably to 
the House in the form of a single amendment in the nature of a 
substitute incorporating the amendments adopted here today.
    Without objection, the staff is directed to make any 
technical and conforming changes and all Members will be given 
2 days, as provided by the House rules, in which to submit 
additional dissenting supplemental or minority views.