Haw. Code R. § 18-235-7-03
"By reason of retirement, disability, or death" describes benefits paid because of retirement, including attainment of age 70-1/2 (to comply with section 401(a)(9)(C), IRC, with respect to required beginning date); disability as defined in section 72(m)(7) (with respect to meaning of "disabled"), IRC; or death. A benefit payment is not made by reason of retirement, disability, or death if it is actually or constructively received prior to retirement, disability, or death, even though the benefit payment is the same as the amount of benefits which would have been enjoyed upon retirement. A payment made by reason of retirement, disability, or death does not include:
(1) An amount paid because of separation from service before retirement;
(2) An employer contribution to a non-qualified pension plan that is deemed to be received by the employee upon vesting before retirement under Treas. Reg. §1.402(b)-1(b) (with respect to taxability of employee when rights under nonexempt trust change from nonvested to vested); or
(3) An early distribution subject to federal penalty tax under section 72(t) (with respect to 10 percent additional tax on early distributions from qualified retirement plans), IRC.
"Employer contribution" means the aggregate amount of contributions that are either made by the employer, or made for the employer by members of a group of affiliated corporations as provided by section 404(a)(3)(B) (with respect to profit sharing plan of affiliated group), IRC. These amounts are included in the employer contribution even though section 72(f) (with respect to special rules for computing employees' contributions) or 101(b) (with respect to employees' death benefits), IRC, may provide that the amounts are considered employee contributions for some purposes. The employer contribution does not include any amounts included in pretax employee contribution or previously taxed contribution. Employer contribution does not include any amounts contributed by a plan beneficiary under an elective right, provided that an amount otherwise qualifiying as an employer contribution shall not be disqualified as to a particular beneficiary solely because (1) the beneficiary determined the contribution amount in his or her capacity as an officer, partner, member, or sole proprietor, or (2) the beneficiary is allowed or is allocated all or a portion of the deduction allowable under section 162 or 404, IRC, attributable to the contribution.
"Exclusion ratio" means the ratio described in subsection (e)(1).
"Pension." A pension:
(1) Provides an employee with compensation for past services, generally measured by such factors as years of employees' service and compensation received;
(2) May be in the form of a (A) periodic or systematic payment of benefits to the employee over a period of years (e.g., usually for life after retirement), or (B) lump sum in lieu of periodic or systematic payments;
(3) Is to be received by the employee by reason of retirement, disability, or death;
(4) Is attributable to employer contribution;
(5) Includes a stock bonus, pension, profit sharing, or annuity plan, as those terms are defined in sections 401 (with respect to qualified pension, profit sharing, and stock bonus plans) and 403 (with respect to taxation of employee annuities), IRC;
(6) Need not be qualified within the meaning of section 401, IRC; and
(7) May be paid to the employee, the employee's spouse upon retirement or disability, or a deceased employee's beneficiary.
"Pretax employee contribution" means the aggregate amount of voluntary contributions made by the employee under any elective right, such as contributions to:
(1) individual retirement accounts to which an employer does not contribute (see subsection (d)(2) for rollover individual retirement accounts),
(2) IRC section 401(k) plans (with respect to cash or deferred arrangements);
(3) IRC section 408(k)(6) plans (with respect to elective salary reduction contributions to simplified employee pension arrangements), or
(4) IRC section 457 plans (with respect to deferred compensation plans of state and local governments and tax exempt organizations); but it does not include previously taxed contribution. These amounts are included in the pretax employee contribution even though the IRC may provide that the amounts are considered employer contributions for some purposes.
"Previously taxed contribution" means the aggregate amount of contributions that:
(1) Were included in the employee's gross income under the Hawaii Income Tax Law, whether or not Hawaii income tax was actually due or paid; or
(2) Would not have been includable in gross income under the Hawaii Income Tax Law applicable at the time of contribution if the employee were a Hawaii resident and the contributions were paid directly to the employee at the time.
Previously taxed contribution includes amounts included in the gross income of an employee under section 402(b) (with respect to taxability of beneficiary of nonexempt trust) or 403(c) (with respect to taxability of beneficiary under nonqualified annuities or under annuities purchased by exempt organizations), IRC.
Example 1: Under the terms of an exempt employees' pension trust Mr. Andrade has $4,000 of previously taxed contribution and the employer has contributed $6,000. Upon retirement on January 1, 1991, Mr. Andrade is entitled to receive $1,200 a year for the remainder of his life, and he receives $1,200 in 1991. The exclusion ratio is the employer contribution of $6,000 divided by the sum of $6,000 (the employer contribution), the pretax employee contribution of zero in this example, and previously taxed contribution of $4,000. Thus the exclusion ratio is $6,000 / $10,000 or 60 percent. Hence, 60 percent of $1,200, or $720, is excluded in 1991 under section 235-7(a)(3), HRS.
Assume that Mr. Andrade's life expectancy determined under this paragraph is ten years. Under applicable federal principles, the $4,000 of previously taxed contribution is prorated over Mr. Andrade's expected life, yielding $4,000 / 10 years = $400 per year. Thus, an additional $400 is excluded in 1991 as the return of previously taxed income. The remaining $80 is included in gross income.
Example 2: The facts are the same as in Example 1. In 1992 and subsequent years, 60 percent of each $1,200 payment shall be excluded regardless of how long Mr. Andrade actually lives.
Mr. Andrade actually dies in late 1995, after receiving $1,200 from the annuity payor in that year. Under the terms of the annuity, the payor has no further liability to make payments to Mr. Andrade or his beneficiary. Mr. Andrade's estate is allowed a deduction on Mr. Andrade's income tax return for 1995 for his unrecovered investment in the annuity under section 72(b)(3) (with respect to deduction where annuity benefits cease before the entire investment is recovered) IRC, as operative under chapter 235, HRS. His estate also is allowed to exclude 60 percent of the $1,200 paid to Mr. Andrade in 1995 while he was alive, as well as the $400 in previously taxed contribution attributable to that payment, but no further deduction or exclusion for the unrecovered employer contribution is allowed under section 235-7(a)(3), HRS.
Example 3: Under the terms of an exempt profit sharing plan Ms. Bicoy, an employee, has contributed $4,000 and her employer has contributed $6,000, all while Ms. Bicoy was working in New York. The plan does not accept after-tax contributions from employees. Upon retirement on January 1, 1993, Ms. Bicoy moves to Hawaii and the plan distributes 12 shares of ABC Co. common stock to her. At the time the 12 shares are distributed in 1993, the stock is worth $100 a share, for a total distribution of $1,200. The exclusion ratio is the employer contribution of $6,000 divided by the sum of $6,000 (the employer contribution), the pretax employee contribution of $4,000, and previously taxed contribution of zero in this example. Thus the exclusion ratio is $6,000 / $10,000 or 60 percent. Hence, $720 is excluded in 1993 under section 235-7(a)(3), HRS, and the remaining $480 is included in 1993 gross income because Ms. Bicoy has no previously taxed contribution. Ms. Bicoy's basis in the 12 shares of ABC Co. common stock distributed to her would be $480 but for this section. Her basis in the stock is increased by $720, to $1,200.
In 1994, the plan distributes to Ms. Bicoy 12 additional shares of ABC Co. common stock, which are then worth $1,500. In 1994, 60 percent of $1,500, or $900, is excluded under section 235-7(a)(3), HRS, and the remaining $600 is included in her 1994 gross income. The basis of the second 12 shares of ABC Co. common stock in the hands of Ms. Bicoy is increased by $900, to $1,500. The basis of her first 12 shares remains $1,200, and any dividends paid on any shares after distribution to Ms. Bicoy are fully taxable to her.
Example 4: Under the terms of a qualified defined benefit plan Mr. Corpuz, a male employee aged 66, is entitled to receive $500 a month for the rest of his life beginning on his retirement date of January 1, 1994. He is unable to determine how much his employer contributed, but he contributed $150 a month in pretax income for the past 120 months. Mr. Corpuz has no previously taxed contribution in the plan. Assuming that Mr. Corpuz uses the method of Treas. Reg. § 1.72-5, calculation of the excluded amount is as follows.
Example 5: Upon retirement, Mrs. Doo, age 65, begins receiving retirement benefits in the form of a joint and 50 percent survivor annuity to be paid for the joint lives of Mrs. Doo and her spouse, age 59. Mrs. Doo's annuity starting date is January 1, 1988. Mrs. Doo is unable to determine how much her employer contributed, but she contributed $50 with each semimonthly paycheck for the past 20 years, totaling $24,000. Her company's retirement plan does not accept pretax employee contributions. Mrs. Doo was paid twice a month. Mrs. Doo will receive a retirement benefit of $1,000 a month, and her spouse will receive a survivor benefit of $500 a month upon Mrs. Doo's death.
In addition, $100 ($24,000 / 240 payments) of each payment to either Mrs. Doo or her spouse is excluded from gross income as a return of capital, under federal rules, until 240 payments have been made to either Mrs. Doo or her spouse.
Example 6: Under the terms of an exempt employee's pension trust, a beneficiary of an employee who dies before reaching retirement age is entitled to receive $1,200 a year for 10 years. Under the terms of the trust, no other benefits are paid to any other beneficiary or to the estate of the deceased employee. Mr. Esaki, an employee, died in January, 1992, before reaching retirement age, and his beneficiary, his daughter Chelsea, receives $1,200 in 1992. As of the date of his death, Mr. Esaki had $4,000 of previously taxed contribution, and his employer had contributed $6,000. If Mr. Esaki had quit in January, 1992, he would have received $5,000 from the trust. Assume that Chelsea is entitled to a death benefit exclusion of $5,000 under section 101(b), IRC.
As in Example 1, the exclusion ratio is 60 percent. Thus, of the $1,200 Chelsea received in 1992, 60 percent, or $720, would be excluded as a pension absent the section 101(b) exclusion. However, the section 101(b) exclusion amount allocable to 1992, namely $5,000 / 10 years $500, is subtracted. The remaining $220 is the amount excluded under section 235-7(a)(3), HRS.
Under applicable IRC principles (section 101(b)(2)(D), IRC, relating to annuities other than joint and survivor annuities), the $5,000 is treated as an additional contribution of previously taxed income. Because $900 a year ($4,000 + $5,000, divided by 10 years) is excluded as a return of capital, an additional $900 is excluded in 1992. The remaining amount, $1,200 - $220 -$ 900 = $80, is included in gross income.
Example 7: The facts are the same as in Example 6, except that the beneficiary of an employee who dies before reaching retirement age is entitled to receive $12,000 payable in a lump sum. Thus, Chelsea receives $12,000 in 1992.
As in Example 6, the exclusion ratio is 60 percent. Thus, $7,200 is allocable to the employer contribution and would be excluded under section 235-7(a)(3), HRS, but for section 101(b), IRC. Under this paragraph, the $5,000 exclusion applies to all amounts other than the previously taxed contribution of $4,000, which total $12,000 -$ 4,000, or $8,000. The proportion of the $5,000 allocable to the employer contribution is thus ($7,200/$8,000) x $5,000, or $4,500. This amount is subtracted from the $7,200, yielding $2,700. The amount of $2,700 is excluded under section 235-7(a)(3), HRS.
Under applicable IRC principles, two additional amounts are excluded: the $5,000 under section 101(b), IRC, and the $4,000 as a return of previously taxed income. The remaining $300 is included in gross income.
Haw. Code R. § 18-235-7-03
§ 18-235-7-03 is based substantially upon § 18-235-7(a)(3). [Eff 2/16/82; am and ren § 18-235-7-03 12/8/94]