Mandatory State withholding - participant moved out of state

[mwyatt]

Employee was a participant in a pension plan located in Massachusetts and also was a resident of Mass.

Participant terminated employment in March of 2013 and has moved to North Carolina (so was a resident of MA beginning of year, now resident of NC).

Has requested payment of his lump sum (not rolling over). Question is whose state tax do we withhold: MA (where he worked and where the benefit was derived from) or NC (where he is now a current resident)?

[MoJo]

Generally, the tax is payable when the payment is includible in "income" and that would be where the participant resides at the time of distribution. Hence, I would say, NC.

[BG5150]

Is there really mandatory state withholding?

[mwyatt]

Yes, in both states (MA and NC) mandatory withholding if Federal tax withholding is required.

Here's a good summary from Mass Mutual I found on the web: http://wwwrs.massmutual.com/retire/pdffolder/forms/rs07262.pdf

Of course it doesn't answer the question on who gets the tax revenue. I know in this situation MA would want the money since he was a resident for part of 2013 and more importantly the benefits were earned while a MA resident working for a MA company.

[MoJo]

Of course it doesn't answer the question on who gets the tax revenue. I know in this situation MA would want the money since he was a resident for part of 2013 and more importantly the benefits were earned while a MA resident working for a MA company.

What MA wants and what it may be entitled to are two different issues. Nothing is considered "income" for tax purposes until it is distributed from the plan. Where it was earned (with the exceptions of PA and AZ, I think), it isn't "taxable" comp. One of the pre-eminent principles of tax law is that the taxing jurisdiction must be the situs of the action giving rise to the imposition of the tax. The "distribution" from a plan/trust/employer plan situated in MA is not an event giving rise to taxation. It is the receipt by the participant of same that actually gives rise to a taxable event - and that, based on the facts given, would be in NC.

[Bird]

In theory I think you are supposed to pay a proportionate share of tax on retirement plan distributions based on where you lived and were taxed when it was earned. I think I remember reading about California going after people who moved out of state but don't recall how successful they were.

If you lived in PA, which does not give a deduction for 401(k) contributions, and moved to NJ (a crazy thought) you could probably (eventually) convince the NJ taxing authorities that you don't owe them tax on your 401(k) distributions, and it would be worth the fight. On a practical level, the address on the 1099-R is going to dictate who thinks they should get the tax and whether or not it is worth battling the state in which the income is received.

[masteff]

In the mid-90's I worked one season testing income tax software, specifically state income tax software (despite generally have less forms, there are 40+ states, so it's lots of program to test). Which leads me to...

Each state handles retirement income and in vs out of state differently. It gets very complicated very quickly.

That said, where you withhold for can be entirely different from where they ultimately owe/pay tax. Your keyword right now is "resident". Unless MA has rules that you must withhold on nonresidents, then you likely do not need to withhold. If in doubt, withhold both and let the taxpayer sort it out when they file their income taxes. Since you know the person had MA source income for at least January thru March, then you would not be entirely out of line. But since the person has self-declared as a resident of NC, you must withhold there. However...

Keep in mind that "mandatory" does not mean the person cannot sometimes elect out of it. Such as: http://www.dor.state.nc.us/downloads/NC-4P.pdf (edit: but read the form carefully, they don't allow to elect out of rollover eligible distributions)

[david rigby]

Well........ several prior discussion threads on very similar topics. More than one comment has opined that ERISA pre-emption will override "mandatory state withholding". (Not all comments agree with this opinion.) Of course, there is the practical consideration of offering tax withholding.

In the case above, the only possible payment appears to be a lump sum, so the only alternative is a direct rollover. It may be worth remembering that one reason for creating the 20% (federal) and 4% (NC) withholding is to encourage the direct rollover. If withholding becomes moot, we all win.