New Jersey taxation of 403(b) distributions

Submitted by joseph nesi on Wed, 2016-08-03 21:19

This is a question about taxation of distributions from a 403(b) plan in regard to New Jersey income taxes.

My client started receiving distributions from his 403(b) accounts this past year, 2015. Therefore, the payments he received need to be reported on the New Jersey income tax return since he is a New Jersey residents.

In New Jersey, 403(b) contributions are after-tax for New Jersey purposes. (They are pre-tax for federal purposes, as would be expected.) Therefore, a portion of the distribution needs to considered as non-taxable for New Jersey purposes. The question of how to determine the taxable versus the non-taxable portion of a 403(b) distribution is not covered by any New Jersey forms, instructions, publications, or regulations that I have been able to find.

The New Jersey tax publications describe how to report distributions received under an IRA plan when the New Jersey basis differs from the federal basis, but does not cover the similar situation with a 403(b) plan. New Jersey has a worksheet for use with IRAs when the NJ basis differs from the federal basis, Worksheet “C”, with a similar methodology to IRS form 8606. However, the NJ worksheet applies only to an IRA account, not a 403(b) account.

In reading through the various NJ forms and publications, it seems that the General Rule Method would be the method to use, however, what is unclear to me is the amount to use as the “Expected return on the contract”. As this account is not an annuity there is no future fixed amount to be received and it is up to the taxpayer to invest and determine how much to wtthdraw each year , which can be in excess of the RMD.

The New Jersey 3-year rule does not apply here, since the total contributions are greater than the total anticipated for the RMD for the first three years.

Specifically my questions are:
1) Can i use the IRA “8606” methodology for determining the basis recovery for the 403b in NJ?
2) If not allowed to use this “IRA” methodology and must use the General Rule, do I use the prior year end balance for the “Expected return on contract” and calculate the Percentage Excludable for each year?

Therefore I am puzzled how to proceed and would welcome any suggestions or comments.



Submitted by Ben Meyer on Wed, 2016-08-03 23:24

  • I have looked over this very question in some detail.  The formal NJ documentation in the instructions for form NJ-1040 and in NJ GIT-1 states virtually nothing regarding this issue except that any contributions previously taxed will not be taxed again.  The general rule method described in the NJ publications as Worksheet “B” is not at all the same as the federal general method, but this is nonetheless the procedure to be followed for purposes of NJ taxation.  The “Expected return on the contract” is the cash value of the contract at the time of the distribution.  This procedure is designed primarily for a conventional annuity, but it is nonetheless the procedure to use for a 403(b) TSA as a variable annuity where distributions are made before the annuity starting date, as is likely the situation here. 
  • The instructions also aggregate all 403(b) distributions during the year into a single number.  Therefore the account value at the end of the year should be used, but the distributions during the year are added back to arrive at the total “Expected return on the contract”.  This is the same methodology as Worksheet “C”.  Thus, Worksheet “C” can be used as a template for your calculations, but it must be a separate Worksheet “C” from the one that you may need for IRA distributions with similar questions of NJ basis.  IRA and 403(b) calculations cannot be aggregated or commingled.
  • An open question will be faced in future years regarding the NJ instructions that “[o]nce calculated, use the percentage on line 3 [of Worksheet “B”] to determine the taxable and excludable amounts year after year.  You must recalculate the percentage only if your annual pension payments decrease”.  This instruction does not suit the circumstances of a 403(b) TSA with distributions prior to the annuity starting date.  But it should be followed since this is the NJ rule.  Therefore, this would be a manual adjustment in future years if using the format of NJ Worksheet “C”.  
  • If you are performing manual calculations each year without the use of Worksheet “C”, you will need to reduce the remaining basis each year by the amount of basis carried out of the plan in previous distributions.  In Worksheet “B”, the remaining basis is entered on line 1, “Your previously taxed contributions to the plan”.
  • The NJ 3-year rule would not apply for a usual 403(b) TSA regardless of the amount of the payments anticipated for the first three years.  The NJ 3-year rule applies only if both the employee and the employer contributed to the plan.  For the usual 403(b) TSA, all contributions are made via a salary reduction agreement.  Therefore, all sums are contributed by the employee.  It is also possible that the contributions are deemed to be made by the employer, as a result of the salary reduction.  Under both interpretations, the conributions are made solely by the employee, or possibly solely by the employer.  Therefore the conditions for use of the 3-year rule are not met under either interpretation.  Additionally, as you stated, the anticipated RMD distributions in the first three years will not reach the level of the total contributions.  (It could, actually, if the employee decides to receive additional distributions in year 2 or year 3 as discretionary distributions beyond the RMD, but the 3-year rule would still not apply.)

Add new comment

Log in or register to post comments