Taxes Withheld May Not be Refundable in PA
Real Life Scenario #1
You put in your retirement papers to start receiving pension benefits or you decide to withdraw IRA retirement monies.
You are a PA resident and you request to begin receiving your company pension plan. The employer will likely request at what income tax rate do you wish to have your federal and state income taxes withheld. The employer may have default rates. If you do specify the desired withholding rate, the employer will use the default rate.
Do you consult with your tax professional as to how to respond? Likely not because it is a simple form that likely appears not to have much significance. If too many taxes are withheld, your think you will get a refund. If too little taxes are withheld, you believe you may have a small underpayment penalty.
Real Life Scenario #2
You instruct your financial advisor/broker to begin to make RMDs (required minimum distributions) from your retirement account. You instruct your broker to withhold federal taxes at the rate of 30% (your federal effective rate) and PA taxes at 10%. You realize that the PA statutory rate is 3.07%, but you despise making quarterly estimated tax payments for the dividend and capital gains that will be reported to PA. Your thinking is that the rate differential will be used to apply against the taxes due on those sources of income.
Again, you do not consult with your tax professional.
What Is the Problem?
The problem is that one of the few benefits of residing in PA is that many forms of retirement are non-taxable. Pension benefits and RMDs are generally not taxable for PA personal income tax (PIT).
Let’s assume that the payor of the pension plan or RMD properly shows the pension or IRA distribution on Form 1099-R as non-taxable for PA and also reflects the PA taxes withheld on those distributions.
Your PA-40 PIT income tax return claims the tax withheld from your retirement proceeds because those taxes were actually withheld from the gross retirement proceeds. You paid those taxes and now you want those taxes applied against your total PA taxes due. Seems perfectly logical.
All is seemingly well, but then that letter from the PA Department of Revenue arrives in the mail. PA is challenging those withheld taxes on your non-taxable retirement benefits. The PA DOR requests a letter from your employer or broker stating that the taxes withheld were done so in error and should not have been withheld. (After all, everyone knows that those retirement benefits are non-taxable and no taxes should be withheld). The DOR further states that without that letter, the withheld taxes will be ignored. Or, the DOR instructs the taxpayer to prove that those withheld taxes were remitted to PA. After all, simply showing the amount of withheld taxes in the tax withholdings box is not proof that the taxes were remitted to PA.
So you call your employer or broker and tell them that you need this letter stating that they made a mistake. This can be a challenge. First of all, the payor of the retirement funds did not make a mistake. You the taxpayer made the mistake by instructing that PA PIT be withheld. While an employer may be willing to sign such a letter for a long-term and valued employee, a brokerage firm may not wish to issue such a letter stating that it made an error when it merely followed your instructions.
Okay. So you cannot obtain the letter admitting a withholding error, surely the payor can provide proof of payment to PA. Again, it is very doubtful that the corporate office of a Wall Street brokerage firm will take such action due to your error. An employer . . . maybe?
Frantic Call to Tax Professional
Realizing that the PA DOR is about to deny these withheld taxes and will be sending you a tax assessment along with interest and penalties, you now decide its time to call your tax professional to decry the authoritarian and oppressive actions of the PA DOR and get your return accepted without any adjustment.
You are likely not going to be pleased when your tax professional explains that a fee will be charged to represent your issue with the PA DOR, the likelihood of not being successful at the DOR department dealing with your tax account, how PA’s appeal process is draconian, and the cost of going to appeals.
Tax Planning Tip:
When life events occur, be sure to share those with your tax professional at your earliest convenience. Preferably, before the event, such as when you decide to retire. You did not wake up one morning and retire, get married, have a child, etc.
If pre-retirement planning had been done, the withholding rate for PA retirement funds would have been discussed as being zero, and the above scenarios could easily have been avoided.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.