For the last 27 years, thousands of Wichita city employees have been overcharged on state income taxes on their retirement benefits.
But going forward, they won’t have to pay any tax at all on those benefits, state and city officials said.
Most employees will be eligible for refunds, potentially totaling thousands of dollars apiece. But they can only get refunds of the last three years of overpayments.
And, as far as anyone can tell, unprecedented.
Since 1985, the city and state have treated contributions to city employees’ pensions as taxable income, as would be the case if they were state employees covered by the Kansas Public Employee Retirement System, better known as KPERS.
But a new interpretation of state law by the Department of Revenue has determined that because Wichita has its own retirement system, which is not part of KPERS, the tax law doesn’t apply to the Wichita pensions.
“It took me by surprise, because we’d been doing it for such a long time,” said City Attorney Gary Rebenstorf, who has worked for the city for 35 years.
To understand the issue, you have to know a little bit about how public pensions are taxed.
In the KPERS system, the money the state pays into employees’ pension benefits is counted as part of their salary for state – but not federal – taxes. When the employees retire and start drawing pension payments, they don’t have to pay state tax on the money because it has already been taxed.
It’s the opposite of the way the U.S. government handles the same tax scenario. The federal government doesn’t tax the pension money at the payroll stage, but then does tax the pension payments after the employee retires.
Wichita employees will now be in a potentially unique situation where the state doesn’t tax the pension benefits as part of the employees’ paychecks under the KPERS statute. Nor will the state tax their benefits after they retire, because that’s prohibited by a different statute, said Richard Cram, director of research and policy at the Kansas Department of Revenue.
Cram and Rebenstorf said the issue arose last year after the Revenue Department sent notices to about 1,500 Wichita employees, saying that they owed the state money because they hadn’t reported their pension benefit as part of their income.
Many of those employees paid the state for back taxes, Rebenstorf said.
But one city employee challenged the Revenue Department, prompting its lawyers to take another look, Cram said.
The revenue lawyers determined that the employee was right, he said.
“They looked at the statute and determined that contributions to the city of Wichita pension system were not under the same requirement (as) KPERS,” Cram said.
Cram said he does not know of any other Kansas city with its own pension program separate from KPERS; Rebenstorf said he’s heard there may be one or two others.
Now, Wichita employees are eligible to apply for a refund for their overpayment of state taxes. To do that, they’ll need to file amended tax returns, Cram said.
The city dispatched a letter to employees with their paychecks Friday, advising them to contact a tax professional “to amend Kansas returns for the maximum number of years possible to recover any taxes due.”
But because of a statute of limitations in the law, the employees can get a refund for only the past three tax years. Anything before that is lost money to the employee, both Cram and Rebenstorf confirmed.
The letter also advised employees not to include their pension income when they file their taxes next year.
“Do not follow the State of Kansas instructions for the Kansas Public Employees’ Retirement System (KPERS) as you may have done in the past,” the letter said.
At this point, it’s unknown how many current and former employees are affected, how much they’ll be due in refunds, and how much less income the state will receive by not taxing them in the future.
“I don’t have an estimate on that,” Cram said. “We’ll be looking at that for sure.”