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Barbara
Barbara, Enrolled Agent
Category: Tax
Satisfied Customers: 2828
Experience:  18+ years of experience in tax preparation; 25+ years of experience as a real estate/corporate paralegal.
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Is a 401k early withdrawal tax taxable on state tax?

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I got an early all withdrawal from my 401K plan in PA. I would like to determine the taxable portion. Early withdrawals are taxed based on the recovery method. The cost recovery method is a way to determine how much of a distribution from a retirement plan or annuity is taxable. Under the cost recovery method, an individual "recovers" all of his/her contributions to a retirement plan, before reporting any PA taxable income.
(http://revenue-pa.custhelp.com/app/answers/detail/a_id/1469)
In my case, my 401K contribution is 3000.00, company match 3000.00, Gross distribution 8000.00.
1) Is company matched amount taxable or not?
2) Based on the recovery method, how much is taxable?
Thank you for allowing me to be of service to you regarding your tax question. Employer contributions are the matching portion of the pre-tax payroll deductions, so your entire withdrawal would be taxable. Per the Pennsylvania Department of Revenue – “Early withdrawals are taxed based on the cost recovery method. The cost recovery method is a way to determine how much of a distribution from retirement plan or annuity is taxable. Under the cost recovery method, an individual “recovers” all of his/her contributions to a retirement plan, before reporting any PA taxable income.” For example, if you contributed $200.00 a month for 80 months to a qualifying pension plan, you contributed $16,000 to the plan. If you took a lump sum distribution of $20,000 before you were qualified to retire; only $4,000 would be taxable. Based on the recovery method, the first $16,000 of the distribution was your own money, leaving only $4,000 as taxable. Therefore, since you contributed $3,000 yourself, the taxable amount would be $5,000 ($8,000 distribution less than your $3,000 contribution). Please let me know if you need further information or clarification. Thank you.
Customer: Thank you for your reply, so is the company matched amount taxable? Right?
Bkb1956: You are correct. The company matched contributions are pre-tax payroll deductions.
Customer: Would you confirm recovery method in PA? In PA state level, 401k contribution is not pre-tax deduction. My understanding is that only earnings are taxed on the PA state level. Since my contribution and company matched are not pre-tax deduction on state level.
Bkb1956: I sent you the guidelines from the Pennsylvania Department of Revenue in my earlier response. Here is the example again: If you contributed $200 a month for 80 months to a qualifying pension plan, you contributed $16,000 to the plan. If you took a lump sum distribution of $20,000 before you were qualified to retire; only $4,000 would be taxable. Based on the recovery method, the first $16,000 of the distribution was your own money, leaving only $4,000 as taxable. Only your contributions are “recoverable”.
Customer: Okay, thank you for your help.
Bkb1956: It’s been my pleasure. If you have any questions in the future, please let me know.
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