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Ask the expert: Why are federal and state reporting of 401(k) deferrals different?
Q: I noticed a difference in the state and federal income figures on my W-2. I made a total of $22,000 in 401(k) contributions last year - the $16,500 maximum plus the $5,500 over-50 catch-up contribution. The $22,000 is deducted from the federal income reported on the W2, but not the state income. Why is that?
A: Both IRAs and 401(k) plans are tax-deferred retirement plans which can be invested in anything from savings accounts to commodity funds, but they differ in that IRA contributions are typically made after the money has gone through your company payroll system, whereas 401(k) contributions usually occur as part of that process. This means that on the federal side, you would deduct an IRA contribution as part of your tax filing, while a 401(k) contribution would generally have already been taken out of reported taxable income. On the state side, though, things are a little different.
The issue on the state side is that different states have different rules on the treatment of income for state taxation purposes. Some states make it easy by basing their taxes on federal adjusted gross income, but other states use a different starting point.
This could mean a couple things with respect to your W-2. The fact that the 401(k) deferral has not been deducted from your state income could mean your payroll service is reflecting the tax procedures for your state, or it could simply mean that they report this way for all states to give employees the flexibility to make the appropriate deductions on their returns where allowed.
So, a good place to start would be by asking someone in your company's payroll department. They could tell you whether the differential was simply an error, and further (while they won't give you specific tax advice) they could probably give you some general background on how 401(k) contributions are handled in your state.
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