Does a PA resident pay income tax on a distribution from an inherited 401-K from out of state?

[TracH21]

My husband's brother passed away last year. He lived in New York and did not own property in Pennsylvania. 

My husband, a Pennsylvania resident, received an inheritance which was a share in the distribution of his brother's 401K.  My husband received a schedule K-1 (Form 1041) from his brother's estate in New York.   

We are reporting this income on both our Federal tax return and on a New York Nonresident return. 

My questions are as follows:

1) Is there Pennsylvania inheritance tax on this and do we need to file the inheritance tax form? It is not from a Pennsylvania source.   

2) Is this inheritance taxed in Pennsylvania as income and does it need to be reported on our Pennsylvania tax return? 

3) Because this inheritance is a 401K distribution, does that change the way it is treated in Pennsylvania?

4) If this inheritance is not taxed on our Pennsylvania return, how do we indicate that in Turbo Tax?

Thank you.

[DianeW777]

The answers to your questions are shown below.  It's best to complete your New York (NY) nonresident return first, the prepare the Pennsylvania (PA) return last. If you already started the return note the income and tax liability from the NY return so that you can enter the necessary information on your PA return.

1. Is there Pennsylvania inheritance tax on this and do we need to file the inheritance tax form? It is not from a Pennsylvania source.   
   • No, he was not a Pennsylvania (PA) resident, no inheritance tax would be filed in PA.
2. Is this inheritance taxed in Pennsylvania as income and does it need to be reported on our Pennsylvania tax return? 
   • Yes, you must also report the K-1 on your PA return.  PA will give you credit for taxes paid to another state on the same income (see details below).
3. Because this inheritance is a 401K distribution, does that change the way it is treated in Pennsylvania?
   • Yes, see the information next.  NOTE: A lump-sum distribution from an employer-sponsored retirement plan made prior to the normal retirement age or length of service requirement under the plan for disability is taxable to the extent it was not previously taxed. Payments made to the participant’s estate or designated beneficiary as a consequence of the participant’s death are not taxable.  PA Personal Income Tax Instruction (see page 27)
   • See the screen image below and select the right category for tax exempt treatment.
4. If this inheritance is not taxed on our Pennsylvania return, how do we indicate that in Turbo Tax?
   • You will tax the income from the K-1 and take a credit as indicated above - details below.

The credit for taxes paid to another state on the same income is used on your resident state because they do not want you to pay taxes twice on the same income.  As the resident state all worldwide income must be included.

The credit for tax paid to another state on the same income will be the lesser of:

1. the tax liability actually charged by the nonresident state, OR
2. the tax liability that would have been charged by your resident state

                                              

[TracH21]

Thanks for responding. I'm still confused. 

The screen shot you indicated is for retirement plans in Pennsylvania.  Just to clarify, this is NOT retirement income, but rather an inheritance from a different state.   The 401K was distributed to the estate in New York, and the estate distributed shares to the beneficiaries.  My husband's share was reported to us on Schedule K-1 (Form 1041) Beneficiary's Share of Income, Deductions, Credits, etc.   

You sited that  "Payments made to the participant’s estate or designated beneficiary as a consequence of the participant’s death are not taxable. "   Wouldn't that mean that this income is not taxable in Pennsylvania?  

Thanks again.

[DianeW777]

Since it is K-1 income and you have a statement with the K-1 that specifically states this is inherited retirement, then the amount should not be taxable to PA.  Either do not enter an amount for your state or look for a place to subtract this when completing the PA return. Keep all the documents with your tax return should you need to explain later.

@TracH21