I withdrew my 401k since I quit my job, why am I being taxed both federally and state?

[Cynthiad66]

Generally, anyone can make an early withdrawal from 401(k) plans at any time and for any reason. However, these distributions typically count as taxable income. If you're under the age of 59½, you typically have to pay a 10% penalty on the amount withdrawn.  Most states tax your withdrawals also.

Use the link below for additional information about early withdrawals from a 401k:

Understanding the Consequences of an Early Withdrawal From 401k

[Edited: 1/26/22 1:09PST]

[Opus 17]

Withdrawals from a tax-deferred retirement account like a 401(k) are always subject to regular income tax.  If you are under age 59-1/2, or under age 55 when you leave the company, you also pay a 10% penalty for early withdrawal.

[Opus 17]

@Cynthiad66 

Half this answer makes no sense.  Copy-paste error?

[stoonie08]

I guess my my confusion lies with my situation. I am living in Texas, but I work remote from California. I feel like I am better off working in my current state because of that income tax. I never once stepped foot in California, but yet I still need to abide by those rules. Just feels a bit unfair. 

Thank you for the response!

[Opus 17]

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@stoonie08 wrote:

I guess my my confusion lies with my situation. I am living in Texas, but I work remote from California. I feel like I am better off working in my current state because of that income tax. I never once stepped foot in California, but yet I still need to abide by those rules. Just feels a bit unfair. 

Thank you for the response!

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So you pay federal tax for sure.

Whether you pay CA state tax on your 401k withdrawal is complicated, but it sounds like you are being treated as a California resident.  You are a California resident if you are domiciled in California, that is where your permanent home is located.  You can be domiciled in California even if you are working and living out of state for a long time.  Changing your domicile requires that you both establish a new domicile and take active steps to abandon your old domicile, such as selling your home, getting a new physician in your new location, changing church memberships, changing your voter and car registration, and so on.  There is no one single factor that controls where your domicile is located.  See here for more.

https://www.ftb.ca.gov/file/personal/residency-status/index.html

https://www.ftb.ca.gov/file/personal/residency-status/part-year-and-nonresident.html

If you are domiciled in California, then you owe CA income tax on all your world-wide income, no matter where it was earned from and no matter where you living when the income is paid.  That's just the law, and every state handles domicile basically the same way.

If you have never lived in CA, then you don't owe any income tax in California, even if you work remotely for a CA-based company.  You have made a mistake somewhere in Turbotax.  Is your employer withholding CA income tax even though you don't live in CA?  If you are not having CA withholding from your check, why are you filing a CA return?  

If you have never stepped foot in CA but you have CA tax withholding, you should be filing a non-resident return.  Turbotax should be asking you to manually allocate each item of income to CA (wages, 401k distribution, interest and dividends, etc.).  In your case, your CA allocation for all your income items is zero.  That will result in no CA income, no CA tax owed, and a full refund of any withholding.

[stoonie08]

Thank you for that info!

This makes more sense to me, I am having my income withheld from my employer so I know I need to file CA state taxes, I was just really confused about the 401k withdrawal. I am domiciled in Texas so I think I did mess up my return somewhere along the way.

Thank you for the clarification! I will now redo my CA state taxes from the beginning. 

[Opus 17]

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@stoonie08 wrote:

Thank you for that info!

This makes more sense to me, I am having my income withheld from my employer so I know I need to file CA state taxes, I was just really confused about the 401k withdrawal. I am domiciled in Texas so I think I did mess up my return somewhere along the way.

Thank you for the clarification! I will now redo my CA state taxes from the beginning. 

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You need to be filing a CA non-resident return, not a resident return.  And when Turbotax asks you to allocate your income between CA and TX, none of your income is from a CA source so indicate zero. 

[Critter-3]

STOP having CA withholding if you live in TX ... doing so opens you up to audit letters from CA looking for taxes from you.  

[Opus 17]

Yes, that will also likely be a thing. When you file a California tax return saying you have no California income, they are likely to send you a letter making you prove it. It’s too late for this year, and it is more important to fix your tax return first, but you want to cancel your California withholding so you stay off their radar.

[stoonie08]

I'm still understanding how all of this process works, but I know now that I need to change some things. 

[stoonie08]

How do you go about canceling the California withholding? And where do I allocate my income between CA and TX, so that my income from the CA source so indicates zero?

[Opus 17]

@stoonie08 

Tax withholding is handled by your employer’s HR or payroll department.

In TurboTax, if you were starting from scratch, and you enter that your main address is Texas, then as part of your personal information section, TurboTax will ask “did you work or make money in any other state?“   In this case, you will answer “yes“ so that you will trigger TurboTax to add a California package to your tax return. TurboTax should then ask you if you lived in California, if you moved into or out of California, or if you were never a resident of California.

When you indicate that you were never a resident of California, TurboTax should start a California non-resident tax return.  Most taxpayers would also have a resident return for their home state, but Texas does not have income tax so this does not apply to you.

When you have completed your federal tax information, you will go to the California state interview. TurboTax should list out each type of income that you reported on your federal tax return and ask you if it was California income.  For example, if you sold property in the state of California and had a capital gain, that would be California income even though you never lived in California.  Or, if you worked 200 days of the year but 10 days you worked in California because your employer required you to be in California for training, then 5% of your job income would be California income.  Since the retirement account distribution was paid to you while you lived in Texas, it is not California income and you would indicate that the 0% or zero dollars of that income was California income.

You can delete your state return and start over, although I’m not sure where the command for that function is located.

If you were not previously asked to allocate your state income, then my guess is that you accidentally told TurboTax you were a full year resident of the state of California.