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PA Income Tax and Withholding Summary for Employment Related Programs and Benefits

April 25, 2007

In many significant ways, Pennsylvania Income Tax and Withholding laws differ from federal tax regulations. The most notable difference involves Pennsylvania’s taxation of elective employee contributions to 401k and other retirement plans. Having completed the mind numbing task of researching this area, I decided that it might be helpful to others to have a resource for some of their Pennsylvania tax questions.  Or, you may consider using this post as an excellent cure for insomnia. 

In any case, the following is a general summary of Pennsylvania’s tax treatment of various employee benefits and includes links to additional information. The summary is not intended as a substitute for professional tax advise as individual tax situations vary widely.

 

 

 

Compensation includes items of remuneration received directly or indirectly for services as an employee including salaries, wages, commissions, bonuses, stock options, incentive payments, fees, tips, severance payments, early retirement payments, payment for unused sick or vacation time, paid leaves, and holiday pay. Pennsylvania’s tax treatment of "fringe benefits" and "retirement plans" sometimes differs from federal tax treatment as noted below.

  • Pennsylvania Income Tax Rate for Compensation paid by Employers(Tax Rates)

Effective January 1, 2004, Pennsylvania’s personal income tax rate increased from 2.8% to 3.07%. For employer withholding purposes, the increase applies to all compensation paid or made available after December 31, 2003, even if the compensation was earned for a period prior to the payment date.

Unlike the federal income tax law, contributions to a 401(k) or employee contributions to other types of retirement plans are considered part of the employee’s taxable compensation and are subject to withholding requirements. The employee contributions are treated the same, whether made inside or outside a cafeteria plan. Employer contributions to qualified retirement plans (like matching contributions to a 401(k) are not subject to Pennsylvania income tax or withholding.

Distributions from a retirement plan (including 401(k), 403(b) and SIMPLE plans) after age 59 ½ are not subject to PA Personal Income Tax.

As to other types of elective retirement plans, any direct employee contribution of compensation to a qualified employer plan (as defined in IRC §409A(d)(2)), such as a qualified retirement plan under IRC § 401(a) (including 401(k) plans), tax-deferred annuity plan or contract under IRC § 403(a) or (b), simplified employee pension under IRC § 408(k), SIMPLE retirement account under § 408(p), IRC § 457(b) eligible deferred compensation arrangement or IRC § 501(c)(18) trust, is subject to Pennsylvania personal income tax and employer withholding at the time of the contribution. Likewise, amounts that an employer deducts from an employee’s compensation and contributes to such a plan is considered taxable compensation at the time of the deduction and is subject to employer withholding.

Like 401k plans, any direct employee contribution to a 457(b) plan is subject to Pennsylvania personal income tax and employer withholding at the time of the contribution. Distributions made from the plan after age 59 ½ are not taxable under Pennsylvania Income Tax.

Adoption Assistance Expenses reimbursed by an employer are taxable income subject to withholding in Pennsylvania despite federal tax exclusion under Internal Revenue Code § 137; unless such services are provided directly by the employer or procured beforehand by the employer.

Generally, if an employee has deductions from his wages for a cafeteria plan and those deductions are for “health and welfare benefits”, the employer can reduce the gross wages before calculating the withholding. Examples of allowable deductions would be premiums for health insurance, eye plans, and dental plans. Deductions that are not allowable include employee elective retirement contributions and dependent care expenses.

Day care facilities provided by an employer are not income to the employee; however, reimbursement of off site day care or for day care expenses is income to the employee and is subject to withholding.

De pendant Care Assistance Reimbursements or payments by an employer are income to the Employee and are subject to withholding

Short and Long Term disability pay are not considered income in Pennsylvania if provided as part of an insurance plan offered through a third party insurer.   STD and LTD plans are treated as taxable income to employees and are subject to payroll tax withholding if paid by the employer and if any of following are part of the employer’s plan:

a)     The plan is discriminatory in favor of highly compensated employees;

b)     Amounts received during a period of sickness or disability for services performed during another period or to which the employee would have been entitled regardless of whether he was sick or disabled, 

c)      Payments for unused sick leave, or 

d)     Payments paid in lieu of regular wages for a period during which an employee is absent from work on account of injury or sickness and computed with reference to: 

(i) the period the employee is absent from work; and 

(ii) the employee’s regular rate of compensation and without regard to the nature of such injury or sickness.

Employee contributions to nonqualified deferred compensation arrangements through salary reduction are taxable at the time of deduction by the employer and are subject to payroll tax withholding. Act 40 of 2005 adopted Federal income tax receipt of income rules for purposes of computing when deferred compensation under a nonqualified deferred compensation plan is subject to Pennsylvania personal income tax. Distributions from nonqualified deferred compensation plans are subject to tax on the gain over the amount previously taxed when deferred into the plan. Residents who had compensation deferred while a nonresident are subject to tax only on the amount received over and above their contributions, regardless of whether tax was paid to another state on the deferred compensation. However, if the deferred compensation program meets the three conditions of a recognized retirement plan (below), the distributions will be treated as any other recognized retirement plan and will not be taxed.

Taxation of deferred compensation under the following situations is outlined below:

1. Employee voluntarily elects to defer payment of current salary to a later year.

2. Employee voluntarily elects to defer part of salary, which is then contributed to a nonqualified pension plan and trust (rabbi trust). The employer also made contributions to the plan. (The plan is similar to an 401(k) plan, but not qualified.

3. Employer dictates that part of employee’s salary will be deferred and paid in later years.

Job related educational assistance and training assistance or payments made by an employer is not taxable, but non job related assistance provided to employees or their dependents is taxable income for Pennsylvania Income tax purposes.

The taxation of Health Savings Accounts and Archer MSAs generally follows federal rules. Under the federal rules, employer contributions are excluded from the employee’s taxable income and employee contributions are deducted from income if they meet the criteria outlined in the Internal Revenue Code. Distributions that are not used for qualified medical expenses will be taxable as interest income. These changes will apply to tax years beginning after December 31, 2005.

Contributions made by employers or labor unions to an IRA are not subject to income tax.

Distributions including the income on the plan assets are not subject to income tax if made upon or after the employee’s retirement under the terms of the plan. A federally qualified rollover or transfer between plans is not subject to income tax. Other distributions are taxable on the amount of income on plan assets. 

Contributions to any qualified tuition program as defined in section 529 of the Internal Revenue Code, including those offered by other states, will be deductible from taxable income.  The amount deducted for each designated beneficiary cannot exceed the annual limitation on gifts permitted by the Internal Revenue Code for purposes of federal estate and gift tax, which is currently $12,000. The deduction cannot result in taxable income being less than zero.

Distributions used for qualified higher education expenses, as well as undistributed earnings in the accounts, will not be taxable. Federally qualified rollovers between accounts and beneficiary changes will also not be taxable events for Pennsylvania purposes. Distributions that are not used for qualified higher education expenses will be subject to tax. These changes will apply to tax years beginning after December 31, 2005.

Contributions made by employers or labor unions to federally qualified retirement plans like Defined Contribution Plans, Defined Benefit Plans, Keoghs, and other pension plans are not subject to income tax.

Contributions to a qualified pension plan made by an employee, whether through payroll deduction or a salary reduction agreement and included in the employees income and are subject to withholding.

Distributions including the income on the plan assets are not subject to income tax if made upon or after the employee’s retirement under the terms of the plan. A federally qualified rollover or transfer between plans is not subject to income tax. Other distributions are taxable on the amount of income on plan assets. 

Contributions made by employers or labor unions to a SEP are not subject to income tax.

Distributions including the income on the plan assets are not subject to income tax if made upon or after the employee’s retirement under the terms of the plan. A federally qualified rollover or transfer between plans is not subject to income tax. Other distributions are taxable on the amount of income on plan assets. 

Benefits paid by an employer or labor union under a supplemental unemployment benefit plan are not subject to Pennsylvania income tax.

Payments for Public Assistance or unemployment compensation by a government agency are not subject to Pennsylvania Income Tax.

  • Union Dues

Union dues are excluded from income if union membership is mandated by the contract between the union and the employer. Ritz v. Commonwealth, 432 A.2d 169 (Pa. Cmwlth. 1981).

Disability, Retirement, of other payments arising under the workmen’s compensation acts, occupational disease acts or similar legislation by any government are exempt from Pennsylvania Income Tax.

 

ADDITIONAL RESOURCES:

The Commonwealth of Pennsylvania publishes an informational booklet on Employer withholding obligations for various employee benefits. The Pennsylvania Department of Revenue also maintains a searchable "Commonly Asked Questions" section on its website. Guidance from the United States Internal Revenue Service on the Federal Taxation of employee fringe benefits can be found in Publication 15-B (2/2007), Employer’s Tax Guide to Fringe Benefits. 

 

DISCLAIMER ON TAX INFORMATION: This Pennsylvania Employment Law Blog Site is made available by the lawyer or law firm publisher for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. By using this blog site you understand that there is no attorney client relationship between you and the attorneys of Russell, Krafft & Gruber, LLP. The Pennsylvania Employment Law Blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.

To ensure compliance with requirements imposed by the U.S. Internal Revenue Service in Circular 230, we inform you that any tax advice contained on this site (including any links provided) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the U.S. Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this communication.

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