Directive PD-00-2

Subject: Withholding of North Carolina Income Tax from Pensions, Annuities, and Deferred Compensation
Tax: Individual Income/Withholding Tax
Law: G.S. 105-163.1(11a) and (11b), G.S. 105-163.1(14) and G.S. 105-163.2A
Issued By: Personal Taxes Division
Date: July 20, 2000
Number: PD-00-2

This Directive addresses the new withholding law requiring State income tax to be withheld from pension payments to residents of this State. The law was enacted in 1999 by House Bill 1466, Chapter 414 of the 1999 Session Laws; amended in 2000 by House Bill 1559, Chapter 126 of the 2000 Session Laws; and is effective for tax years beginning on or after January 1, 2001.

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. The North Carolina forms referred to in this Directive may be obtained by calling the Department at (919) 715-0397. The forms are also available on the Department's Website. 

Definitions

Unless otherwise specified below, the definitions, provisions, and requirements of section 3405 of the Internal Revenue Code with respect to federal withholding on pensions apply to State withholding on pensions.

Pension payer - A payer or a plan administrator with respect to a pension payment under section 3405 of the Code.

Pension payment - A periodic payment or a nonperiodic distribution, as those terms are defined in section 3405 of the Code.

Withholding Required

Effective January 1, 2001, a pension payer required to withhold federal tax under section 3405 of the Code on a pension payment to a North Carolina resident must also withhold State income tax from the pension payment. If a payee has provided a North Carolina address to a pension payer, the payee is presumed to be a North Carolina resident and the payer is required to withhold State tax unless the payee elects not to have tax withheld. A pension payer that either fails to withhold tax when required to do so or to remit tax that is withheld is liable for the tax.

A pension payer must treat a pension payment paid to an individual as if it were an employer's payment of wages to an employee. If the pension payer has more than one arrangement under which distributions may be made to an individual, each arrangement must be treated separately.

Amount to Withhold

In the case of a periodic payment, as defined in Code section 3405(e)(2), the payer must withhold as if the recipient were a married person with three allowances unless the recipient provides an exemption certificate (Form NC-4P) reflecting a different filing status or number of allowances. Form NC-4P, Withholding Certificate for Pension or Annuity Payments, is used by a recipient of pension payments who is a North Carolina resident to report the correct filing status, number of allowances, and any additional amount the recipient wants withheld from the pension payment or to elect not to have State income tax withheld. In lieu of Form NC-4P, payers may use a substitute form provided it contains all the provisions included on Form NC-4P.

For a nonperiodic distribution, as defined in Code section 3405(e)(3), four percent (4%) of the distribution must be withheld. A nonperiodic distribution includes an eligible rollover distribution as defined in Code section 3405(c)(3). State law differs from federal law with respect to eligible rollover distributions. Federal law imposes a higher rate of withholding on eligible rollover distributions than on other nonperiodic distributions. State law imposes the same rate of withholding on all nonperiodic distributions.

Election Not to Have Income Tax Withheld

A recipient may elect not to have State income tax withheld from a pension payment unless the pension payment is an eligible rollover distribution. A recipient of a pension payment that is an eligible rollover distribution does not have the option of electing not to have State tax withheld from the distribution.

Except for eligible rollovers, a recipient of a pension payment who has federal income tax withheld can elect not to have State income tax withheld. Conversely, a recipient who has State income tax withheld can elect not to have federal income tax withheld.

An election not to have tax withheld from a pension payment remains in effect until revoked by the recipient. An election is void if the recipient does not furnish the recipient's tax identification number to the payer or furnishes an incorrect identification number. In these cases, the payer must withhold on periodic payments as if the recipient were married claiming three allowances and on nonperiodic distributions at the rate of four percent (4%).

Exceptions to Withholding

Tax is not required to be withheld from the following pension payments:

1. A pension payment that is wages.
    
2. Any portion of a pension payment that meets both of the following conditions: a. It is not a distribution or payment from an individual retirement plan as defined in section 7701 of the Code. b. The pension payer reasonably believes it is not taxable to the recipient.
    
3. A distribution described in section 404(k)(2) of the Code, relating to dividends on corporate securities.
    
4. A pension payment that consists only of securities of the recipient's employer corporation plus cash not in excess of $200 in lieu of securities of the employer corporation.
    
5. Distributions of retirement benefits from North Carolina State and local government retirement systems and federal retirement systems identified as qualifying retirement systems under the terms of the Bailey/Emory/Patton settlement that are paid to retirees who were vested in the retirement system as of August 12, 1989.

Notification Procedures for Pension Payers

A pension payer is required to provide each recipient with notice of the right not to have State tax withheld and of the right to revoke the election. The notice requirements for North Carolina purposes are the same as the federal notice requirements, which are provided in section 3405(e)(10) of the Code. Section D of Federal Regulation 35.3405-1 contains sample notices that may be modified for State purposes to satisfy the notice and election requirements for periodic payments and nonperiodic distributions.

Under federal law, instead of notification that tax will be withheld unless the recipient chooses not to have tax withheld, pension payers may notify recipients whose annual payments are less than $5,400 that no federal tax will be withheld unless the recipient chooses to have federal withholding apply. This notice may be provided when making the first payment. The same provision applies for North Carolina purposes with respect to State withholding from recipients whose annual payments are less than $5,400.

Reporting and Paying the Withheld Tax

A pension payer that is required to withhold State tax from a pension payment beginning in 2001 but is not already registered with the Department of Revenue for wage withholding must register by completing Form AS/RP1, Registration Application for Sales and Use Tax or Income Tax Withholding. The completed form should be mailed to the N.C. Department of Revenue, Business Registration Unit, P.O. Box 25000, Raleigh, North Carolina 27640-0100. The payer will be assigned an account identification number and will receive forms for paying the State tax withheld. The payer will initially be classified as a quarterly filer. The filing frequency may change after the first year depending on the amount of tax withheld during the first year.

A payer that withholds tax from pensions and also withholds tax from wages must report the withholding from pensions with the wage withholding unless the payer chooses to report the withholding from pensions separately. For those payers that do not choose to report the two types of withholding separately, the payment of tax withheld from pensions is due at the time the withholding from wages is due and the payer will be subject to penalties and interest on both types of withholding based on that due date. Payers that also withhold from wages but choose to report the withholding from pensions separately must file Form AS/RP1 to receive a separate account identification number. They will receive separate forms for paying the tax withheld from pensions.

A payer that initially chooses to report withholding from pensions separately may, at any time, begin reporting the two types of withholding together. If combined reporting is preferred, a payer should report the combined withholding under the account number for reporting wages. The payer should complete the Out of Business Notification for the separate pension withholding account and file it with the Department. The separate withholding account will be closed. A payer that initially reports the two types of withholding at the same time may choose to begin reporting the withholding on pensions separately by notifying the Business Registration Unit. The payer must continue to report the two types of withholding together until the payer receives the separate account identification number and remittance forms from the Department. In either case, the payer must file separate annual reconciliations for the year in which the choice is changed.

Annual Statements

Payers must report pension income and State tax withheld on Federal Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-sharing Plans, IRAs, Insurance Contracts, etc. Form 1099-R must be given to the recipient on or before January 31 following the calendar year in which the pension payments were made. The payer must file an annual report with the Department of Revenue that reconciles the amounts withheld from each recipient. Payers choosing to treat pension withholding as wage withholding must report the two types of withholding on one annual reconciliation report. Payers subject to both wage withholding and pension withholding that report the two types of withholding separately must file separate annual reconciliations for each type of withholding. The annual reconciliation for withholding from pensions is due on or before February 28.