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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client (age 62, resident of Colorado) owns an IRA. Are IRA distributions subject to state income tax? If he wants to do a Roth conversion, will it be subject to state income tax?

Answer: It depends on the state. Colorado imposes a flat 4.63% state income tax is on its residents’ federal taxable income. Since both IRA distributions and Roth conversions are taxable on the federal level, they are both generally taxable on the Colorado state level.

However, Colorado allows a pension/annuity subtraction for taxpayers who are age 55 or older as of the last day of the tax year, or who are receiving a pension or annuity because of the death of the person who earned it. The pension/annuity subtraction allows a Colorado taxpayer to reduce his taxable income by the taxable amount he receives as a distribution from his IRA, up to $20,000 (or $24,000 if age 65 or older).

For example, suppose your client accurately reported $60,000 as taxable income on his federal income tax return. Generally, your client would owe $2,778 (4.63% of $60,000) in state income taxes. But suppose that $20,000 of his taxable income came from a distribution from his IRA. He can exclude this $20,000 distribution, resulting in a new taxable base of $40,000.

Additionally, the pension/annuity subtraction rule applies to Roth conversions. Therefore, as long as your client converts $20,000 or less to a Roth IRA in the taxable year, and doesn’t use the pension/annuity subtraction on another taxable distribution throughout the year, he may exclude the converted amount from the Colorado income tax.

Each state has different rules when it comes to income taxes, and there’s no universal rule as to the taxability of IRAs at the state level.

Sources: Col. Rev. Stat. § 39-22-104(f)(4); FYI Income 25: Pension/Annuity Subtraction, http://www.colorado.gov/cms/forms/dor-tax/Income25.pdf.

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