State tax on pension distributions

[Guest hyper]

Scenario:

The payroll system maintains home addresses for employees. The payroll system indicates the state in which the employee lives has a state income tax. At retirement, the employee provides a W-4p (withholding info for pension payments) indicating a home address in a state with no state income tax. As a result, the retirement distribution has no state tax withheld.

Does the employer have any liability if the retirement payment is based on the W-4p home address, even tho the home address in the payroll system shows a different address ?

Anyone else run into this problem ?

[mbozek]

There have been previous discussions on withhholding of state income tax by pension plans on the distributions message board. There are two differing opinons. One group beleives that the plan has an obligation to follow state income tax witholding laws for distributions paid to participants. The other opinion is that state income tax withholding laws are preempted by ERISA from applying to plan distributions so it is the employee's responsibility to pay any applicable state income tax. Why does the plan care what address the employee uses as a residence?

[david rigby]

This may be one of the relevant prior discussions:

http://benefitslink.com/boards/index.php?showtopic=29380

[Guest hyper]

Mbozek:

The plan cares about the participants state of residence becasue state taxes are withheld based on the participant's state of residence. We do not want to fight the good fight about ERISA preemption of state law or determine what state laws are enforceable in other states. The ER just wants to withhold state taxes, if required by such state.

The question is, if the employee completes a w-4p at plan distribution with an address different than the one on the ER's payroll, is there any liabiilty to the ER for relying on the w-4p ? Note: The w-4p contains an address for a non-income tax state and the payroll system has an address for a state that has an income tax.

Pax:

Thank you for the reference but I revewied that thread before posting and it did not address this issue.

[E as in ERISA]

Why not just tell the participant that they have been flagged for inconsistent home addresses. Tell them that you want to send the checks to the correct residence and you need the paperwork to be consistent.

[Guest TAG]

Hyper,

Which state is the actual residence and which state is listed on the payroll system.. Not all states are mandatory so maybe a non-issue, or maybe an issue.

TAG

[Appleby]

The withholding should be done for the participant’s state of domicile, which could be different from the current address of record. In general, your state of domicile is where you get your driver’s license, motor vehicle registration, have your primary residence- where you register to vote and such. When is doubt, ask the participant to clarify. Many individuals establish temporary residence for various reasons, and use the temporary address for mailing purposes. At our firm, we attempted to address the issue by designing a distribution requests for that required the participant to indicate the state for which withholding taxes should be applied…

[david rigby]

... indicate the state for which withholding taxes should be applied…

Could we all just elect Florida or Texas?

[Lori Friedman]

Oh pax, why don't you go watch a Braves game or something? (Actually, you probably will be watching tonight's game -- P.Martinez v. J.Smoltz -- sweet!)

[mbozek]

Hyper: your posting is a good example of why the plan should not withhold state income tax from plan distributions because the payor cannot be sure of what to withhold. (There is no answer to the question you raised. A plausable answer is that the employee has changed his residence to another state now that he is retired.) State income taxation is based on residence not domicile (since a person can only have one domicile but can have more than one residence). Every state e.g., NY, PA, NJ, NC, determines residence differently. States cannot collect income tax from pension distributions of non residents.

Secondly residence for income tax purposes is the responsibility of the taxpayer not the payor who cannot know what state the employee will owe taxes to. Employers do not withhold employee's state income taxes for states in which they do not do business because there is no legal obligation to do so. It is a waste of plan assets to pay someone to determine what state income taxes should be withheld from plan distributions since state withholding laws are preempted.

[Appleby]

mbozek,

You are right in saying that states cannot collect income tax from pension distributions of non residents- this ( ban on source taxes)- effected by Public Law No: 104-95, prevents a state from taxing pension income of former residents.

Residence / domicile- appears to be potato/potato for state tax purposes. Public Law No: 104-95 says that

No State may impose an income tax on any retirement income of an individual who is not a resident or domiciliary of such State (as determined under the laws of such State)

…For this purpose, it appears residence is limited to legal residence for purposes stated earlier- not just where you are living at the moment or living for a few months out of the year. An example would be snow-birds who go to warmer climates during the winter months. While in (say) Florida, they are residing in Florida. However, the determination of their legal residence for tax withholding purposes would be determined by where they are registered to vote- the state for which their driver’s license is issued etc.

By the way, why is it do you suppose that some of the largest and most prominent financial institutions and plan administrators performs state tax withholding? state tax withholding is tedious and creates more of a nuisance than anything else. It seems unlikely that any payor would assume such a responsibility unless they have to.

[mbozek]

A: No one knows what that statement means. When does a resident become a non resident/domicilary for the purpose of taxing a lump sum distribution. States provide for taxation of income earned during the year before a resident leaves the state. But can a resident who moves to his new residence in mid year be a non resident/domiciliary if he has his LSD sent to his new address after quitting his job and moving to his new home but before he sells his residence in the state where he worked. Hasnt he established a new residence/domicile at the time the check is mailed to him. Given the confusion of when someone ceases to be a resident for state income taxes how can a plan withhold state income taxes on pension distrbutions. I have reviewed the income tax residency requirements of 4 states this year and the logic of the rules are of the I know it when I see but I cant explain it variety. Suggest you read the instructions to the NJ 1040 or the PA 40 form. By the way snow birds keep careful records of the days they reside in FLA as evidence that they do not reside in NY for the minimum 183 days a year required to pay NY income tax.

Financial institutions provide services such as state tax withholding because they can charge a fee to the plan for doing it. (Some admin people in financial institutions may not be aware that state income tax withholding is not applicable to pension plans. I question why a plan should pay for a service if 1) it is not required under law and 2) the plan administrator has no way of knowing whether the withholding is being done correctly. It doesnt make sense to withhold state taxes from pension distributions which will be refunded when the employee files a tax return.

[Guest Harry O]

mbozek -

Is there a cite for your statement that state withholding is preempted by ERISA? If not, what level of opinion would you give that ERISA preempts state withholding tax laws -- reasonable basis? more likely than not? should?

[Guest TAG]

By the way, why is it do you suppose that some of the largest and most prominent financial institutions and plan administrators performs state tax withholding? state tax withholding is tedious and creates more of a nuisance than anything else. It seems unlikely that any payor would assume such a responsibility unless they have to.

Appleby - you're the man. Major complex for those who do all states and the rest of the world for that matter.

MBozek - Welcome to the big leagues. By the way... PA taxes 401k contribs on the way in and only state that does. Gee, so which part is taxable in which state....in kind vs. cash- what's basis? Cap gain rates - Wow. Stick to plan admin, your clents will thank you.

TAG, CPA, APM, QKA

[Guest b2kates]

As the Plan's Trustee or Paying agent, we withheld state taxes. I was responsible for maintaning the knowledge base for all the states.

It was our position that for withholding purposes, we used the address on the federal w4P for determining residence for state tax withholding.

In the absence of a W4P in our files, we defaulted to the address that the payment was sent to.

Hope this is helpful.

Mbozek, we often had states assert penalties against the plan for noncompliance with thier state withholding rules which had specific provisions for retirement plans/

[mbozek]

TAG: I dont understand your point. No one is disputing the right of a state to tax wages of employees who work or live in the state which can include amounts contributed to a 401(k) plan. (NJ taxes 403(b) elective contributions but not 401(k)). Withholding of distributions from pension distributions is another story because because it prevents uniform plan adminstration which is the primary reason for preemption. Northwest Airlines v. Roemer 603 Fsupp 7 held that state tax levys on retirment benefits were preempted. Further there is a constitutional principal that prevents state taxation of entities that do not have a presence in a state. A plan that operates out of NY and has no operations in Ca does not have to withhold Cal income tax on distributions sent to a retiree living in CA. I am still waiting for someone to provide a state law penalty to a non resident entity for failing to withhold taxes.

There is no benefit for plans to pay for unnecessary services such as withholding of state income tax on retirement benefits on non residents just because the services are available.

[Guest keano]

Regarding withholding of state income tax on pension distributions, the Ninth Circuit addressed the preemption issue in Plumbing Industry Retirement Fund Trust v. Franchise Tax Board, 909 F.2d 166, 12 EBC 1993. The Court held that ERISA does not preempt California income and unemployment tax withholding procedures. Based on the reasoning in this case, it seems dangerous to advise plan administrators not to follow state withholding laws. I am not aware of any other cases addressing ERISA preemption of state withholding laws. Does anyone else know of any cases?

I have heard that some multiemployer plans have stopped complying with state withholding laws based on Title 4 USC Chapter 4, Section 114, which forbids states from imposing income tax on retirement income of a person who is not a resident of the state. Anyone have any thoughts on this?

[mbozek]

The problem with the 9th circuit's holding that Cal voluntary income tax witholding was permitted on pension benefits is that the Supreme Court has subsequently adopted the position in the Egelhoff case that state laws relating to distributions are preempted if they prevent uniform administration of pension plans. Clearly the various state withholding laws are not uniform.

The cal. laborer's case is somewhat unique because the fund and most participants were located in the same state that was trying to attach benefits. The issue that you overlooked is what is the risk to an out of state plan that has no presence in a state that requires income tax withholding of benefits paid to a state resident. Under the minimum contact doctrine a state cannot enforce its tax laws against a non resident plan which does not maintain a presence within the state. Under applicable federal law a state cannot enforce its income tax laws on pension distributions paid to a non resident who earned the benefits while a resident of the state.