State Tax on Deferred Compensation After Moving: The 10-Year Payout Rule.

A VP of engineering spends seven years deferring $110,000 a year into her employer's nonqualified deferred compensation plan, retires from a San Jose company at 58, and moves to Reno. The plan's default election is a single payment 90 days after separation. State tax on deferred compensation after moving turns on that election and almost nothing else, and on an $840,000 balance the wrong box costs $84,157.

P.L. 104-95 was signed on January 10, 1996, after years of states chasing retirees across state lines for tax on pensions funded while they lived there. The operative sentence runs one line: no State may impose an income tax on any retirement income of an individual who is not a resident or domiciliary of such State. It applies to amounts received after December 31, 1995.

Qualified money is protected no matter how it comes out. Section 114(b)(1) lists trusts under §401(a), annuity plans under §403(a), annuity contracts under §403(b), simplified employee pensions under §408(k), individual retirement plans, §457 plans, governmental plans under §414(d), and §501(c)(18) trusts. Lump sum, installments, or annuity, it doesn't matter. The state you left is done.

Nonqualified money is where the condition sits. Section 114(b)(1)(I)(i) reaches any plan described in IRC §3121(v)(2)(C), which is the general definition of a nonqualified deferred compensation plan, but only if the income is part of a series of substantially equal periodic payments made not less frequently than annually for the life or life expectancy of the recipient or a period of not less than 10 years. Ten years is a floor, not a guideline. Nine annual payments protect nothing. The statute does let the amounts move for a cost of living adjustment or a predetermined formula, so a plan that credits earnings between installments still qualifies.

One more detail decides the case: residency is tested when the payment is received, not when the compensation was earned. Every dollar in that plan was earned in California. That is irrelevant if the payments arrive while she is a Nevadan and the schedule qualifies.

California's own guidance says the same thing. FTB Publication 1005 tells nonresidents that plan distributions received after December 31, 1995 are not taxable by California, and the rule reaches certain nonqualified deferred compensation as well. Without §114 the lump sum is plainly California source income, because compensation is sourced to where the services were performed regardless of when the check clears. Spreading also flattens the brackets: ten $84,000 years total $42,506 on that same schedule, so even a state that could tax the stream would collect half.

Retirement income is a defined term, and most of an executive's exit package is not in it. Stock options, restricted stock units, severance, and bonuses are compensation, not retirement income, and the old state still taxes the share earned by working there. A nonresident who exercises nonqualified options granted in California allocates the spread by California workdays over the vesting period, the same allocation that governs California RSU tax after moving out of state. Leaving changes what happens to the rest, not to that.

The shield runs one direction. Section 114 stops the state you left and says nothing about the state you joined, which taxes the installments like any other resident's income. The reason the Reno election produces $0 is Nevada, not the statute. Run the same facts into Oregon and the installments are taxed at up to 9.9%.

There is one carve-out that runs the taxpayer's way. Section 114(b)(1)(I)(ii) treats income received after termination of employment under a plan maintained solely to provide retirement benefits above the limits of §401(a)(17), §401(k), §401(m), §402(g), §403(b), §408(k), or §415 as retirement income no matter how it is paid. Those are excess benefit plans, which exist only because a qualified plan hit a ceiling. New York has applied the pension source law that way: in Advisory Opinion TSB-A-16(1)I it concluded that a lump sum paid after termination to a nonresident former employee under a nonqualified plan was not New York source income. Most elective top hat plans, the ones that let you defer salary and bonus, are not, so read the plan document before leaning on this.

This is the part that catches people. IRC §409A controls when you can pick or change a payout, and the initial deferral election generally has to be in place before the year you perform the services. Changing it later is a subsequent deferral election, and §409A(a)(4)(C) puts three conditions on it: the new election cannot take effect for at least 12 months, the payment has to be pushed out at least 5 years from when it would otherwise have been made, and an election tied to a payment scheduled at a specified time has to be made at least 12 months before the first scheduled payment. Deciding to switch from a lump sum to installments the month you accept a job in Austin usually means the money is not moving for another five years.

Whether that 5-year push applies once or to every payment turns on plan language. Treas. Reg. §1.409A-2(b)(2)(iii) treats a right to a series of installment payments as a right to a single payment unless the plan provides at all times that each installment is a separate payment. One sentence in a plan document changes the whole analysis, so find it before you draft an election.

The federal side does not change either way. Installments are still wages, reported on a W-2, taxed at ordinary rates in the year received, and generally free of Social Security and Medicare tax, because §3121(v)(2) made the employer run FICA on the deferral when the substantial risk of forfeiture lapsed and the nonduplication rule in Treas. Reg. §31.3121(v)(2)-1 keeps it from being charged twice. What the schedule moves is state tax and bracket exposure, which on a balance this size is most of the decision.

My verdict: if you hold a deferred compensation balance and any chance of leaving a high-tax state, the payout election is worth more than the timing of the move, and it has to be settled years earlier. The residency has to be real too. Section 114 protects a nonresident and does nothing for someone the FTB successfully argues never left, which is a fight over where you actually live, not over the plan.