Tax law pains some national firms

Not all states follow U.S. lead in upgrading retirement accounts

January 22, 2002|By Eileen Ambrose | Eileen Ambrose,SUN STAFF

The new federal tax law allows workers to sock away more money in retirement accounts, but for some Maryland companies with offices across the country, the change provides a potential headache.

Most states' income tax laws, including Maryland's, track federal law. But unlike Maryland, not all those states automatically conform when the federal law changes.

Unless the legislatures of those states change their laws to conform, national companies may find that workers' higher 401(k) contributions are fully sheltered from state income tax in one state but not in another.

Here's why: The federal tax law passed in June raised the limits on what workers could contribute to retirement accounts. The limit this year, for example, for an individual retirement account rises by $1,000 to $3,000; goes up $500 to $11,000 for a 401(k), and, if the plan permits, allows workers 50 and older to make an extra "catch-up" contribution of $1,000 to a 401(k).

If a state doesn't comply with the federal law, that means any additional money to a retirement account above the old limits would be subject to state income tax, although it would still be sheltered from federal income tax until it's withdrawn from the plan.

For employers responsible for withholding income taxes from workers' paychecks, "it's an administrative headache," said David Wray, president of the Profit Sharing/401(k) Council of America in Chicago.

Not only would an employer have to keep track of differing state tax treatment of 401(k) contributions, but the employer would also need to keep records to make sure that workers who already paid income tax on some of their 401(k) contributions are not taxed again by the state when that money is later withdrawn, Wray said.

According to the council, the 14 states out of compliance are Arizona, California, Hawaii, Idaho, Indiana, Iowa, Kentucky, Maine, Massachusetts, Michigan, Minnesota, North Carolina, South Carolina and Wisconsin.

In the past, when federal tax laws changed, states eventually fell in line. This time may be different.

Many states face budget deficits and may be reluctant to lose tax revenue, experts said.

"If this were 1998, state legislatures would pretty quickly make this change. The problem is, it isn't 1998," said Martha Priddy Patterson, a director with Deloitte & Touche in Washington.

"It's 2002, and we know that the tax base for those states is going to be lower than it's been in the past because of the economy. It will be a brave state legislature that will want to get up and say, `Let's cut our tax base some more,' whereby doing nothing, their tax base will remain as it was," she said.

The prime example is California, which has a $12.4 billion deficit. By complying with federal law, the state stands to lose an estimated $44 million in revenue this year. Legislation has been introduced in the state to conform to federal law.

So, what's a company that operates in complying and noncomplying states to do?

"You're going to see a variety of responses," said John Scott, director of retirement policy with the American Benefits Council, an employer trade group in Washington. Some are taking a wait-and-see approach, while others are permitting higher contributions to retirement accounts and hoping the states follow federal law, he said.

Bethesda-based Lockheed Martin Corp., with employees in nearly every state, is studying the issue and waiting to see what noncomplying states do, said spokesman James Fetig. If states end up not following federal law, the defense company may contact state governments on behalf of workers and encourage compliance, he said.

Towson-based Black & Decker Corp. has employees in several affected states and expects most states to retroactively conform to federal law, said spokeswoman Barbara Lucas. The big question is California, headquarters of the toolmaker's hardware and home improvement group that employs nearly 1,000.

Right now, workers companywide can contribute up to the new 401(k) limit of $11,000 this year, and older employees can make catch-up contributions, she said.

Many state legislatures are just beginning to meet, and there's plenty of time to make adjustments to workers' paycheck withholding if states don't comply, she said. But if states end up varying from federal law, Lucas said, "It will be a burden in ... administrative costs and record-keeping."

Ciena Corp., a Linthicum-based telecommunications equipment company, said dealing with differing state tax laws is just part of being a multistate business. The company, which employs more than 3,000 in several states, including California and Massachusetts, is advising workers in affected states about the situation and potential consequences, said spokesman Glenn Jasper.

That way, if some states don't comply, workers there won't be surprised to see state income taxes taken out of their 401(k) contributions. "Employees are not going to have to deal with this on their own. Payroll will work with them on it," Jasper said.

Deloitte's Patterson said she's concerned that employers may postpone permitting catch-up contributions until it's clear how states will treat that income.

"People who need the catch-up ought to start this year, as soon as possible," she said. "People who need the catch-up only have a limited number of years between being age 50 and time to retire."

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