100% Federal Withholding?
We have a client who wants to take a distribution but have 100% of the distribution withheld for federal taxes. They also stated that within a week they will rollover the same dollar amount to the account. The client stated that they are doing this on the advice of their accountant. I’m having a hard time thinking of any possible reason for doing this. Absolutely no situation comes to mind where this makes any sense. Any thoughts?
Permalink Submitted by Bruce Steiner on Tue, 2008-11-25 19:12
To avoid a penalty for underpayment of estimated tax.
Permalink Submitted by Alan Spross on Tue, 2008-11-25 20:17
I sure hope they have not used up their one permitted rollover for a 12 month period or they have a taxable distribution to contend with.
To add to Bruce’s statement, withholding is considered to be paid equally over the entire year, and a quarterly estimate is credited only at the time of payment. A large withholding from a paycheck or investment at year end can wipe out quarterly underpayment penalties incurred for earlier quarters, so this maneuver can save penalty dollars.
Permalink Submitted by Janine Janine on Tue, 2008-11-25 22:20
Is it not true that as long as your estimated taxes plus withholding taxes equal or exceed the previous year’s total tax liability there is no penalty?
Thank you.
Permalink Submitted by Alan Spross on Tue, 2008-11-25 22:57
Sometimes that works, but there are exceptions.
1) 110% of previous year for higher incomes (150,000 joint for 2007)
2) If paying by estimated taxes, each quarter’s requirement must be separately satisfied. In other words, if you were short on Q 1 and Q2, no matter how much you pay in for Q3 and 4, you are subject to penalty. This may be the case for what the poster is doing. However, if you overpay in an earlier quarter, the excess is applied to the next quarters.
Withholding is different because it can be applied retroactively and make up for prior quarterly shortfalls. Some people use a combination of estimates and withholding, both of which are accounted for differently.
For some people doing a large late year conversion without adequate taxes paid in previously, they will have to complete the dreaded Sch AI (annualized income installment method) on Form 2210 to get any penalty reduced to reflect the date of the income. That is, unless they have a withholding source to apply per above.
Permalink Submitted by mk foss on Wed, 2008-11-26 01:29
I heard Natalie Choate speak about this exact strategy. If someone takes a distribution today and has it 100% withheld, they could pay it back in January before the 60 days have expired and not pay tax on the original withdrawal.
Natalie recommends that you return the funds to another (or a new) IRA if you’re doing this to pump up you withholding and avoid tax on the (short term) distribution.
Mary Kay Foss