Directive PD-98-4 (Revised)

Subject: Roth IRAs
Tax: Individual Income Tax
Statute: G.S. 105-134.6, G.S. 105-228.90, and § 408A of the Internal Revenue Code
Issued By: Personal Taxes Division
Date: December 4, 1998
Number: PD-98-4 (Revised)

(This Directive replaces PD-98-4, dated November 6, 1998. It clarifies that the amount rolled over in calendar year 1998 from a traditional IRA to a Roth IRA is not required to be allocated ratably over the 1998 through 2001 tax years. The taxpayer can elect to include all of the rollover in gross income for the 1998 tax year.)

This Directive addresses the North Carolina income tax consequences of contributions to and distributions from a Roth IRA. If you have questions about this Directive, you may call the Personal Taxes Division of the North Carolina Department of Revenue at (919) 733-3565. You may also write to the Division at P.O. Box 871, Raleigh, N.C. 27602-0871.

Section 408A of the Internal Revenue Code addresses the federal income tax consequences of a Roth IRA. This Code section was enacted as part of the federal Taxpayer Relief Act of 1997 and was effective for tax years beginning on or after January 1, 1998. On October 2, 1998, Governor Hunt signed into law House Bill 1326, Chapter 171 of the 1998 Session Laws. This law updated North Carolina's reference to the Internal Revenue Code from January 1, 1997, to September 1, 1998, causing North Carolina to adopt the provisions of the Taxpayer Relief Act of 1997, including all of the Roth IRA provisions.

Contributions

For federal tax purposes, contributions to a Roth IRA are different than contributions to a traditional IRA in that the contributions to a Roth IRA are not deductible in arriving at federal adjusted gross income in the year of contribution. The contributions are also not deductible for State tax purposes.

For federal tax purposes, contributions may be made to a Roth IRA only if the taxpayer's federal adjusted gross income does not exceed certain threshold amounts. A taxpayer who qualifies to contribute to a Roth IRA for federal tax purposes and who has additions to federal taxable income on the State return that result in an adjusted gross income in excess of the federal threshold amount still qualifies to contribute to the Roth IRA for State tax purposes.

An individual cannot contribute to a traditional IRA after the individual reaches age 70 1/2. For both federal and State tax purposes, an individual can continue to contribute to a Roth IRA after the taxpayer reaches age 70 1/2.

Rollover Contributions

The tax consequences of a rollover from an IRA to a Roth IRA differ depending on whether the IRA that is rolled over to the Roth IRA is another Roth IRA or a traditional IRA. For both federal and State tax purposes, a tax-free rollover from one Roth IRA to another Roth IRA may be made once during any one-year tax period.

For both federal and State tax purposes, a rollover from a traditional IRA to a Roth IRA is not tax-free except to the extent the amount is attributed to nondeductible contributions to the traditional IRA. Such a rollover can occur only if, in the year the funds are withdrawn from the traditional IRA, the taxpayer's federal adjusted gross income does not exceed $100,000. The taxpayer must file a joint return if the taxpayer is married. In that case, the combined incomes of both spouses are considered in determining whether the rollover is permissible. The amount of rollover contributions is not included in adjusted gross income for purposes of determining the taxpayer's eligibility to make the rollover.

For both federal and State tax purposes, the amount of a rollover contribution from a traditional IRA to a Roth IRA is included in gross income in the year the funds are withdrawn from the traditional IRA to the extent the funds represent deductible contributions to, and earnings of, a traditional IRA. Because the withdrawn amounts are included in federal taxable income, the taxpayer is entitled to a retirement benefits deduction of up to $2,000 pursuant to G.S. 105-134.6(b)(6)c.

For rollovers from a traditional IRA to a Roth IRA during calendar year 1998, the amount to be included in gross income for both federal and State tax purposes is allocated ratably over the 1998 through 2001 tax years. This rule is mandatory, not elective, and applies only to rollovers on or before December 31, 1998. If the individual dies before the end of the four-year period, the remaining installments of the rollover must be included in gross income in the year of death. Although the income is spread over a four- year period, it is only one distribution from the traditional IRA and qualifies for only one $2,000 retirement benefits deduction for State tax purposes. The deduction must be claimed on the 1998 return to the extent the rollover is included in federal taxable income, regardless of whether any tax benefit is derived from the deduction. If less than $2,000 is included in federal taxable income in 1998, the remainder of the deduction must be claimed in subsequent years until the deduction is claimed in its entirety.

  • Example: Taxpayer John Doe rolls over $6,000 from a traditional IRA to a Roth IRA in 1998. Mr. Doe must include $1,500 ($6,000/4) in gross income on each of his tax returns for tax years 1998-2001. Mr. Doe is entitled to a $2,000 retirement benefits deduction for State tax purposes. However, because only $1,500 of the $6,000 distribution is included in federal taxable income in 1998, the deduction on that return is limited to $1,500. The remaining $500 of deduction ($2,000 - $1,500) must be claimed on the 1999 return. If federal taxable income for 1999 is a negative amount or other adjustments on the North Carolina return reduce North Carolina taxable income to $0, the $500 deduction must still be claimed on the 1999 return although it provides no tax benefit.

Distributions

For both federal and State tax purposes, a qualified distribution from a Roth IRA is not includable in income. A distribution is a qualified distribution if it is not made within the five-year period beginning with the tax year in which the individual first contributed or rolled over amounts into the Roth IRA, and the distribution is:

    • made on or after the date the individual becomes 59 1/2, or
    • made to a beneficiary (or to the estate of the individual) after the individual dies, or
    • made because the taxpayer is disabled or to pay qualified first time home buyer expenses.

Because the qualified distribution is not included in federal taxable income, the taxpayer is not entitled to the retirement benefits deduction.

A nonqualifying distribution from a Roth IRA is includable in gross income to the extent the distribution represents earnings on contributions to the Roth IRA. Because the distribution is included in federal taxable income, the taxpayer is entitled to the retirement benefits deduction on the North Carolina return.