Relating to individual income taxation by exempting certain amounts received from nonqualified deferred compensation plans and including retroactive applicability provisions

Description

House File 961 excludes up to $500,000 each year of a nonqualified deferred compensation plan or attributable earnings from the computation of net individual income tax for someone who is disabled, 55 years of age or older, or the surviving spouse of an individual or a survivor having an insurable interest in an individual who would have qualified for an income tax exemption.

The Bill applies retroactively to tax years beginning on or after January 1, 2025.

Background

Beginning in tax year (TY) 2023, 2022 Iowa Acts, House File 2317 (Income Tax Rate Reduction and Exemptions Act), exempted all income defined as retirement income from the State individual income tax for disabled taxpayers and taxpayers aged 55 years or older. The exemption also applied to a deceased person’s retirement income that is received by a surviving spouse or a person with an insurable interest in the deceased person. House File 2317 did not alter the full retirement pay exemption available to retired military personnel, which is not based on age or disability. House File 2317 also excluded retirement income from the calculation of Iowa’s universal and age-based low-income full exemptions from individual income tax. According to the Internal Revenue Service, a nonqualified deferred compensation (NQDC) plan is an elective or nonelective plan, agreement, method, or arrangement between an employer and an employee to pay the employee compensation in the future. A qualified deferred compensation plan is subject to compensation deferral limits, similar to a 401(k) plan, while a nonqualified deferred compensation plan is deferred compensation with no federal legal deferral limit that is subject to tax at a later date. 42 C.F.R. §413.99 defines qualified and nonqualified compensation plans for federal tax purposes. An NQDC plan does not adhere to federal requirements specified in 26 U.S.C. §401(a). An NQDC plan may be used by individuals who already contribute the maximum to qualified compensation plans and represent another method for tax-free retirement contributions. An NQDC plan does not allow early distributions, loans, or rollovers (unlike qualified plans), and federal tax must be paid on distributions when made. An NQDC plan can have varying structures, compositions, and conditions for disbursements. The Iowa Department of Revenue (IDR) submitted a rulemaking to the Administrative Rules Review Committee in February 2024 that listed qualified retirement income for income tax exemptions. Nonqualified deferred compensation plans described in 26 U.S.C. §409A do not qualify for an income tax exemption under current Iowa law, per the IDR.

Assumptions

• An NQDC plan, undefined in the Bill, may include any plan to defer any compensation for any length of time.
• According to PLANADVISOR, there was $191.0 billion in assets in NQDC plans nationwide as of 2022.
• The Internal Revenue Service (IRS) reported $10.029 billion in pension or annuity income from NQDC plans in TY 2022 from approximately 307,000 taxpayers who have voluntarily submitted information regarding their NQDC income.
• Iowa includes approximately 0.95% of the U.S. population in 2024, according to the U.S. Census Bureau.
• The amount of reportable Iowa revenue from a NQDC plan in 2022 is estimated to be $3.6 million, increasing annually via inflation.
• Inflation is estimated at 2.3% through TY 2031, according to Moody’s.
• The individual income tax is 3.8% in TY 2025 and beyond.
• This fiscal analysis assumes approximately 20.0% of potential Iowa NQDC tax exemptions are not estimated to impact tax revenues due to noneligibility or other tax factors, creating a $3.1 million decrease in General Fund revenue in TY 2025 due to the Bill.
• All of TY 2025’s fiscal impact will occur in FY 2026.
• The income surtax for schools is a local option tax that is based on a taxpayer’s Iowa income tax liability. Law changes that lower Iowa income tax liability also lower the amount of income surtax owed by any taxpayer subject to the surtax. For this projection, the surtax is assumed to equal 2.5% of State individual income tax liability.
• Due to the voluntary nature of reporting federal income, the fiscal impact to the State from the Bill may be higher than what is estimated in this fiscal analysis, which does not include voluntary income beyond what was reported to the IRS in TY 2022.

Fiscal Impact

The exemption in House File 961 is estimated to decrease revenue to the General Fund by the following amounts:

• FY 2026 = $3.1 million
• FY 2027 = $3.2 million
• FY 2028 = $3.3 million
• FY 2029 = $3.3 million
• FY 2030 = $3.4 million
• FY 2031 = $3.5 million

The decrease in tax liability is also estimated to decrease the statewide local option income surtax for schools by the following amounts:

• FY 2026 = $78,000
• FY 2027 = $80,000
• FY 2028 = $81,000
• FY 2029 = $83,000
• FY 2030 = $85,000
• FY 2031 = $87,000

Sources

• Internal Revenue Service
• PLANADVISER
• Moody’s
• U.S. Census Bureau
• Iowa Department of Revenue
• Legislative Services Agency