A New York agency has found that a lump-sum settlement payment from a nonqualified deferred compensation plan by a New York employer to a former employee that is not a New York resident is not subject to New York state income taxes.

The decision interprets 4 USC 114(a), which prohibits states from taxing “retirement income” paid to non-residents, even if the compensation is paid by a resident employer or was earned while the payee was a resident. The statute defines “retirement income” as including payments under a nonqualified deferred compensation plan, if the payments are made periodically for life or at least ten years.

In the case at hand, the employee, who was not a NY resident, had commenced receiving periodic payments from two nonqualified deferred compensation plans of his former NY employer, before the employer had gone bankrupt. As part of the bankruptcy settlement, the employee’s payments were commuted to a lump sum. The NY agency held that the lump sum payment still qualified as “retirement income” for purposes of the rule in 4 USC 114(a), in spite of the fact it was not a periodic payment. It’s unclear if the agency would have reached the same result if the lump sum had been been the original form of payment, instead of resulting from the bankruptcy.

Although the facts are limited, employers should keep in mind the rule in 4 USC 114(a) when paying out periodic nonqualified deferred compensation payments to nonresidents, so that appropriate state taxes are withheld.