Taxation of IRA withdrawals for New Jersey income tax purposes

Karin Price Mueller/The Star-Ledger for the Star Ledger writes: Q. How are IRA withdrawals handled for New Jersey income tax purposes? I have both traditional and Roth IRAs. I understand that for Federal income tax purposes, all traditional withdrawals are fully taxed, and all Roth withdrawals are tax-free. But I do not know how they are handled for New Jersey. Also, what’s the best way to take withdrawals?

— Soon to retire

A. Good question.

New Jersey conforms to all of the federal tax treatment of Roth IRAs, said Gail Rosen, a Martinsville-based certified public accountant. Traditional IRAs are different.

"Contributions to an IRA are not deductible for New Jersey purposes in the year they are made, therefore, such contributed amounts are not taxable when withdrawn from the account," Rosen said. "Interest, dividends and other earnings credited to the IRA are subject to New Jersey tax upon withdrawal.

Any contributions you made to an IRA before you moved to New Jersey are treated as if you had been living in New Jersey at the time you made the contributions, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

Kiely said your IRA consists of your contributions, earnings, plus amounts, if any, rolled over from other pension plans. In general, he said, the contributions were taxed when they were made.

Interest, dividends, and other earnings credited to an IRA are subject to tax upon withdrawal, he said. In addition, any amounts that were rolled over into an IRA from a pension plan are subject to New Jersey tax when they are withdrawn.

Kiely offered some advice on the withdrawals, and investing in IRAs in general.
He said investing IRA funds in tax-exempt investments is not recommended because federal tax law says all income earned inside an IRA is taxable upon withdrawal.

However, an exception exists in New Jersey with respect to the taxability of an IRA withdrawal when the IRA funds are invested in obligations which are exempt from New Jersey income tax.

"The Gross Income Tax Act specifically excludes from gross income (1) interest received from obligations of the State of New Jersey or any of New Jersey’s political subdivisions, or (2) interest received from direct Federal obligations which are statutorily free from state or local taxation," Kiely said. "Thus, where the interest received by the taxpayer on an IRA distribution is from exempt obligations which are directly owned by the taxpayer in the IRA plan, the interest is exempt from New Jersey income tax."

Qualified distributions from a Roth IRA are excludable and do not have to be included in New Jersey gross income in the year received, whether it is a periodic distribution or a lump-sum distribution, he said.

Also consider that because Roths don’t have an RMD, it may make sense to take the RMD first from your traditional IRA, then determine the best place, and best tax scenarios, before you take any additional funds that are needed.