Federal and State Income Tax Withholding

[Guest Cliff Langwith]

The answer to this seems logical, which always scares me. So I have to ask the experts. If a 401k Plan must make refunds due to ADP testing and the participant has requested state withholding as well as Federal - Does state withholding come out of the gross amount or the net amount after Federal?

[2muchstress]

I don't understand why anyone would give an employee the option of withholding when a return of excess contributions is being made. If it is not eligible for rollover, withholding is not mandatory, and would only create more work than necessary.

Also, state withholding is not mandatory for most states. California and Oregon residents must opt out, so most TPA's that I am aware of are no longer offering state withholding.

To answer your question, if I understand it correctly, any distribution in which state tax is being withheld, you would calculate the state tax on the gross amount of distribution. Unless you live in CA, then the state w/h is calculated as a % of the federal w/h.

[david rigby]

I suggest caution on assuming that "withholding is not mandatory for most states." More states are changing these rules.

[mbozek]

Most states with income tax have some form of withholding requirement, e.g., NY, or require estimated tax payments equal to some % of state tax, e.g., NJ requires 80% of state tax due be paid quarterly. Failure to pay minimum amount will result in interest penalty being assessed and maybe an under payment penalty as well. Texas has no income tax.

[2muchstress]

It was late when I posted last, so let me clarify. States with income tax usually do have some sort of withholding requirement on gross income. I was referring specifically to distributions from qualified plans. I also must claim that I practice in the Northwest, and am familiar with the way things are done in the west. I fully understand that there is a huge difference between the East and West on many things.

However, not to digress any further, my point was that there is no reason to withhold from a return due to an ADP failure. How big can the return actually be, $10,500 at max. If that's the case, then a qualified plan is probably not the best idea for these folks. If a return of excess conts. is going really mess up somebody's tax standing at the end of the year, then they should fire their accountant.