At what point does New Jersey tax a traditional IRA?

[jbarnettfilms12]

I'm filing my taxes with the state of NJ and have withdrawn a large portion of money from a traditional inherited IRA for the year 2021. I had Charles Schwab hold a percentage of NJ taxes for the year as I expected to pay state tax on the withdrawals, yet Turbotax says I'm getting all of that money back in a refund and just owe more federal.  When I looked up state law on taxes it says:

"Contributions to an IRA are subject to New Jersey Income Tax in the year they are made. When you make a withdrawal from an IRA, the amount you contributed is not taxable, since the contributions were already taxed."

Does this mean the taxes were already paid when the money was put into the IRA?  (I can't ask the person who made the contributions because they're no longer living).

 I just want to confirm with someone who may know better than I as no one, including my financial advisor, has provided this information.  

[ErnieS0]

No. IRA contributions are not taxable in New Jersey, but earnings are. You must determine who much was of the total account was contributions and how much was earnings.

The NJ return includes a worksheet to keep track of your remaining after-tax contributions each year, since it is withdrawal proportionally to taxable IRA income and not all at once.

Interest, dividends, and other earnings credited to an IRA are taxable when withdrawn, as are any amounts
that were rolled over into an IRA tax-free from a pension plan.

GIT-2 -IRA Withdrawals

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@jbarnettfilms12 

without the detailed records of the original owner of the IRA showing all contributions and taxed distributions,

you can't know the unrecovered NJ basis.

you have to pay tax on the entire distribution.

If the original owner was not an NJ resident, there is no NJ basis.

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@jbarnettfilms12 

Did you pay NJ Inheritance tax?

Reply back if YES.

[Wiz22]

What is the definition of 'other earnings'? Does it include value appreciation? Simplistically if the value of your holdings increases from $10,000 to $20,000 is the difference considered 'other earnings'?

[DoninGA]

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@Wiz22 wrote:

What is the definition of 'other earnings'? Does it include value appreciation? Simplistically if the value of your holdings increases from $10,000 to $20,000 is the difference considered 'other earnings'?

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Increases or decreases in valuation within a tax deferred retirement account, such as an IRA, is not reported on tax return.  Only when there is a distribution from the account would it be taxable on a return.

[Wiz22]

Sorry. I should have indicated the Other Earnings as applicable to an IRA withdrawal. Contributions of $10,000 are invested in equities which appreciate to $20,000. The entire $20,000 is withdrawn. Is that gain taxable? Is that gain taxable as ordinary income vs. long term capital gain (assuming it was held for the required time period)? 

[DoninGA]

See answer at the top of this thread.

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If your contributions were deducted on Federal 1040 tax return(s) for years of contribution, all distributions later are ordinary income.

There is no capital gains treatment.

NJ  treatment is different and described above.

@Wiz22 

[NJJoy]

My understanding is that NJ treats all contributions to an IRA as though they were taxed when made by you or the original owner of the IRA - just as they would have been had they been made in New Jersey.  That is, regardless of in which state these contributions were originally made, NJ will use them as an exempt basis for determining the taxable portion of the earnings on them (and apply this ever-declining fraction to the amount of your distribution each year).  Each year Turbo tax will bring forward the remaining balance of the exempt amount until final distribution of the IRA.  Hope that helps.

[DaveF1006]

Yes, you are correct. In New Jersey, contributions to an IRA are subject to state income tax in the year they are made. This means that when you make a withdrawal from the IRA, the amount you contributed is not taxable again, since the contributions were already taxed at the time they were made.

However, any earnings or growth on those contributions that were not previously taxed will be subject to New Jersey state income tax when withdrawn. This could explain why TurboTax is showing a refund for the state taxes withheld, as the contributions themselves are not taxable again, but the earnings are.

NJ.gov

@jbarnettfilms12 

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NJ Worksheet C is confusing and tedious and requires a deep understanding to file correctly.

See Worksheet C in the NJ Resident Return Instructions for how to avoid double taxation on that money (i.e. recover it) when you withdraw from your IRA. There is a first year calculation, and then a calculation for all subsequent years. OR use TurboTax to do it, it is the same thing but in a different presentation.

You will need good records showing what you (or the original owner, if inherited) put in over the years, or some way to reconstruct that information.

TurboTax doesn't handle the situation where your IRA and your inherited IRA both have a basis and you take a distribution from both.

[NJJoy]

Yes, you have confirmed my understanding- and the turbotax help desk agrees - the software does NOT handle this situation.  We had to find a workaround- for those finding themselves in the same situation - here's what to do:

(This is for NJ taxpayers who have been taking a distribution from an inherited IRA but now are ALSO taking a distribution from their own traditional IRA - either as a conversion to a Roth, or as an RMD. - Actually, it also is for those who previously took a distribution from a traditional - non-inherited IRA and are now also taking a distribution from an inherited traditional IRA)

Scenario one:  For those who in previous tax years have been reducing the NJ taxes on a distribution of a traditional IRA (inherited or otherwise) by using the exempt basis in turbotax and the pensions/iras etc worksheet (NJ worksheet C in the instructions for NJ1040) but are in this tax year also doing a distribution from a different traditional IRA.  That is, a distribution from both an inherited and a non-inherited traditional IRA.

1.  When you go to the forms for the NJ return, you will see that Turbotax has already populated the worksheet to reflect the basis in the IRA for which you previously took a distribution.  It does the calculation in Part B and enters the "correct" new basis in Part A, 4b (Unrecovered contributions).  The worksheet (and the NJ Worksheet) only let you choose between treating the distribution(s) as the first year or 2nd or later year.  you cannot enter both, even if this is essentially a new calculation reflecting the basis in the IRA for which you have not previously calculated a basis.

2.  Take the basis reflected in Part A 4b and add it to the basis of the distribution from the "new" IRA.  Enter this total as a first year basis in Part A, 4a.

3.  delete all the data form Part B, so that the entry in Part A 4b is blank or reads "0".  The software won't like this, but I think it will work (I'll try filing today!)

Scenario two: For those taking a distribution from both an inherited and non-inherited traditional IRA and have not previously exempted any portion of the previously taxed contributions:

Easy!!  Just combine the bases of the two IRAs creating a single value to be entered at Part A 4a!  Next year this will carry forward, should you choose to exempt a portion of any future distributions.

BTW:  Don't worry if you've previously taken distributions but did not calculate a basis.  That basis is good forever - you will just take a small piece of it each time you use the worksheet!  No need to go back and amend returns!!

Hope this helps.  I know I'm not the only one with this situation.

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@NJJoy 

"regardless of in which state these contributions were originally made, NJ will use them as an exempt basis for determining the taxable portion of the earnings on them"

Why would NJ let you recover tax that you did not pay to NJ?