27 Mar How does N.J. tax these retirement distributions?

Q. I am 67 years old, married, and have $800,000 in traditional IRAs, 401(k)s and 403(b)s. Over decades, I have jockeyed assets within these funds, but never took a taxable withdrawal. I started doing mid-December traditional-to-Roth conversions. Reporting the conversion to the IRS is a piece of cake, but New Jersey stymies me. How do I calculate the excludable portion of the conversion of old, intermingled money? I have been ball-parking but can I continue to do this without attracting unwanted attention? I am being honest, but don’t want to hire a nest-egg forensic analyst.
— Stymied in New Jersey

A. Thank you for your question. Let’s take this step by step.

We’ll start with you IRA.

When you contribute funds to a traditional IRA they may or may not be tax deductible for federal income tax purposes, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

He said if your contributions are made on an after-tax basis, you have what’s called “basis.”

“Basis is tax-speak for your cost. When you withdraw funds from your traditional IRA, you do not have to pay tax on the amount that represents your cost basis,” Kiely said. “New Jersey does not allow an income tax deduction for a contribution to an IRA account, so, you always have tax basis in your IRA for New Jersey tax purposes.”

According to the instruction booklet for the New Jersey income tax return, there are two methods available for dealing with tax basis on your New Jersey income tax return.

Worksheet A is for the Three-Year Method.

“If you will withdraw all of your tax basis within the first three years, it is assumed you are withdrawing tax basis first, Kiely said. Accordingly, your withdrawals will be tax-free until you have withdrawn all of your basis. Then all subsequent withdrawals will be fully taxable.”

If it will take longer than three years to recoup your tax basis, then you use Worksheet B. With this method, part of each withdrawal represents a portion of your tax basis. The balance of your withdrawal will be taxable, Kiely said.

The key to calculating your tax basis is that you have to keep records.

“The problem is most people don’t keep records. If you kept records, you would know the exact amount of your tax basis,” Kiely said. “Each year you would subtract the amount of tax basis you used each year.”

Kiely recommends you back each year and look up the maximum allowable IRA contribution. This could give you a reasonable cost basis amount, he said.
Now to your 403(b).

For federal income tax purposes, contributions to a 403(b) plan are made on a pre-tax basis. Therefore, all withdrawals from a 403(b) plan are fully taxable.

However, in New Jersey, 403(b) contributions are made on an after-tax basis, Kiely said, so for New Jersey income tax purposes, tax basis and the rules above still apply.

“The good news is the 403(b) custodian has been keeping good records for you so the exact amount of tax basis is a known quantity,” he said.

Finally, your 401(k).

“Almost all contributions to a 401(k) plan are made on a pre-tax basis for both federal and New Jersey purposes,” he said. “Some participants may choose to make additional after-tax contributions to their 401(k) plans. But once again, the plan custodian will keep good records.”

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This story was originally published on March 27, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.