Withhold tax in state of residence or state benefit earned?

[Guest SueJ]

We have a plan paying a participant a lump sum of their cash balance plan. Participant recently moved to Illinois. Benefit was earned in NJ. Request indicates that NJ state taxes should be withheld. We have not come across this before. State taxes, if withheld, have always been for the state of residence. Is there a standard rule or does it differ by plan/state?

[Guest tcv]

The general rule is that taxes are withheld based on the state of residence. At one time certain states tried to collect taxes on monthly benefits paid to people who earned them there then moved somewhere else after retirement. The ruling was that this is not allowed.

There is a difference between withholding tax and tax liability. Tax liability is what is reported on your tax return. Withholding is just an advance payment toward the taxes to be due on your return. Note that not all states require withholding from pension payments.

If the participant worked in NJ, then quit and moved to Illinois, then he/she may have to file returns for both states for the year. I think the state of residence at the time payment is made should be the one getting the withholding. If the participant elects to have something withheld and sent to NJ too, I see nothing wrong with complying with his/her wishes.

Disclaimer...I say the above based on experience, but I am not an expert on state taxation.