IRAs and Different State Provisions (1 of 3)

When many people think about the rules that govern IRAs, they see them as universal rules, applicable to everyone equally in all circumstances. While many rules do, in fact, apply to everyone equally, variations in state law can also create significant differences in how IRAs are treated in different states. In order to make sure your plan is as effective as possible, you should be sure it not only addresses Federal law, but the unique challenges that may arise as a result of the specific laws applicable in your state.

1) IRA Deductions/Basis
For federal income tax purposes, if you have compensation (such as earned income from a job), are under 70 ½ at the end of the year and neither you or your spouse are an active participant in a company plan (such as a 401(k) or SEP IRA), you are entitled to a tax deduction for an IRA contribution, regardless of your income. If you have compensation, are under 70 ½ but you or your spouse are an active participant in a company plan, your IRA contribution may be deductible on your federal income tax return, depending on your income.  If you or your spouse actively participate in a company plan and you would like to see if your contributions to an IRA will be deductible, click here.

While the requirements for receiving a federal income tax deduction for an IRA contribution are the same no matter what state you live in, the tax treatment of IRA contributions at the state level varies significantly. Some states, like Florida, have no state income tax and as such, there’s no need to even think about a state income tax deduction. Other states, like New York, have a state income tax, but offer a similar state income tax deduction for IRA contributions as is offered at the Federal level.

Still other states, like Massachusetts and New Jersey, have a state income tax but offer no state income tax deductions for IRA contributions. As a result, if you live in one of these states and make an IRA contribution, you may have State IRA basis, even if you have no basis at the federal level. It’s important to keep track of these amounts so that when you take a distribution from your IRA (or make a Roth conversion) you don’t end up paying state income tax on the same funds again.

By Jeffrey Levine and Jared Trexler

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