If you contribute to a Keogh, SEP-IRA, Money-Purchase or Profit-Sharing Plan as a self-employed taxpayer, or if you have made deductible contributions to an IRA, then you may have a tax issue on distributions from that plan or IRA. (Obviously, this does not apply to Roth IRAs but it can apply to roll-over IRAs.)
Many states follow the federal tax rules, allowing a deduction to these plans. However, Commonwealth of Massachusetts, among others, does not.
That is, in the case of contributions to all of these Plans and even a traditional IRA, Massachusetts gives you no deduction on the contribution. Therefore, you have to take a deduction for that contribution against later distributions. Otherwise, you have paid tax twice on that amount.
To say it differently, because Massachusetts does not allow a deduction at the time of the contribution, i.e., it was “after-tax” money when contributed, you must offset those amounts against withdrawals, amortizing over time, so that you are not taxed on the after-tax contribution when it comes back out as a part of the distributions.
Therefore, you will want to track the contributions made, so that the total can offset the amount taxed by Massachusetts when you withdraw.
We are addressing this issue in an appeal to the Massachusetts DOR Appellate Court, as certain plans face double taxation.