My employer is from PA and I worked and lived in WA for the whole year of 2016. My employer withheld PA taxes and mentioned that it was by mistake and I can request for a refund from PA.====>correct your ER did not have to withhold PA taxes and of course had to mention that it was by mistake. you need to file your PA return as a NON Resident of PA, non PA resident return I mean, for the full refund.
I filed PA non-resident (PA-40) return form. Now I got a question from PA saying that I received income from PA sources so I am liable for payment of PA tax. Is that true? ===>no; there IS NO State Reciprocal Tax Agreement BETWEEN pa AND WA; NO INCOME TAX IN wa. as said, you are not liable for PA income taxes since you were not physically present in PA but were in WA where you lived and worked; Each state has its own taxing authority, dept of revenue mostly I guess, You generally only pay taxes in the state you reside and/or work in. For example you live in one state and work in another. If they both have state taxes it is possible to have to include the income on both state returns. Generally there is a deduction or credit you take so you are not double taxed. Just because a company is headquartered in a different state does not mean you pay taxes to that state. There usually needs to be a physical presence where you are working or living to pay tax. So you need to let then know of this and Check with your state, PA, taxing authority.
should I pay taxes to a state where I did not work or lived.=====>as mentioned above; no. many of stat e Dept of revenue EEs are not very reliable tax advisers.