Ask the Expert: Grand way to be tax-free

In the example you've given, the entire $40,000 would be free of state tax, assuming you're at least 591/2. The IRA distribution qualifies for the $20,000 annual exclusion. And New York doesn't tax Social Security benefits at all, even if they're subject to federal tax.

The $20,000 exclusion applies to annual income from all your tax-deferred retirement accounts. If you took $8,000 from a 401(k) plan, and $12,000 from IRAs, for example, the entire $20,000 would be state tax-free. You qualify for this break as soon as you turn 591/2.

Each taxpayer qualifies for the annual exclusion as an individual. In other words, if a husband and wife each qualify for a $20,000 exclusion, together they can exclude $40,000 of retirement account distributions from state taxes. But you can only claim the exclusion on distributions from your own retirement accounts. You can't pass an unused part of your exclusion to your spouse. Distributions from inherited retirement accounts also qualify, regardless of the beneficiary's age, if the original owner was at least 591/2 when he or she died. But if there are several beneficiaries, they must share the $20,000 annual exclusion that belonged to the original retirement account owner.