In general, it's taxable in the state where you earned it. The way that payments are structured determines this. If the payments were made over a period of ten years or more, it would be taxable in the state in which you currently live.
If you are living in a different state now, you will have to complete a nonresident return to report the income.
Prepare your nonresident return first in TurboTax.
How deferred compensation is taxed
Generally speaking, the tax treatment of deferred compensation is simple: Employees pay taxes on the money when they receive it, not necessarily when they earn it.
- For example, say your employer provides you $80,000 a year in salary and $20,000 a year in deferred compensation.
- You work there for 10 years, and after retiring, you get your deferred compensation in a lump sum.
- Each year you work, you'll be taxed only on $80,000 worth of income.
- The year you receive your deferred money, you'll be taxed on $200,000 in income—10 years' worth of $20,000 deferrals.
There are different ways to structure the payment of deferred income, but your options depend on the plan details as set up by the employer. The distribution schedule is almost always pre-determined and specified in the document that controls the administration of the deferred compensation plan. In other words, it's critical to understand from the beginning what your options will be down the road.
Residence can affect overall tax status
Your federal tax obligations for deferred compensation will be the same regardless of where you live when you receive the money.
However, where you live could have a significant impact on your state tax liability—if your payments are structured the right way.
"Generally, deferred compensation is taxable in the state where the employee worked and earned the compensation, regardless of whether the employee moves after retirement," says David Walters of Palisades Hudson Financial Group in Portland, Oregon.
"However, if the employee has elected to take the deferred compensation payments over a period of 10 years or more, the deferred compensation payments are taxed in the state of residence when the payments are made."
This can make a big difference if you move to a state that has no state income tax, such as Florida, Washington or Nevada, or at least to one with a lower income tax than where you earned the money.
Click here for strategies for managing your tax bill for deferred compensation.
Click here for how to file a nonresident state return.
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