Does tax owed on CARES act 401k withdrawal count towards the $1,000 limit associated with an underpayment penalty?

[bugman-74]

I qualified for a CARES act 401k withdrawal, and took out $65,000. I will be paying the taxes associated with this distribution in even increments in 2020, 2021, and 2022. Normally I would not anticipate owing >$1,000 and therefore no concern with underpayment penalty. However, the addition of the taxes related to the CARES withdrawal will no doubt push me beyond owing more than $1000. Does this mean I should be making estimated payments, or are COVID related distributions exempt from underpayment penalty?

[DanaB27]

Yes, you should make estimated tax payments for 2021 and 2022 if you expect to owe more than $1,000 since there is no exception because of the COVID distribution.

Generally, most taxpayers will avoid this penalty if you either owe less than $1,000 in tax after subtracting their withholding and refundable credits, or if they paid withholding and estimated tax of at

• least 90% of the tax for the current year or
• 100% of the tax shown on the return for the prior year (110% for those whose AGI is higher than $150k), whichever is smaller. 

[dmertz]

Only the 1/3 portion of the Coronavirus-Related Distribution (CRD) that is included on your 2020 tax return adds to your taxable income from which your 2020 tax liability is determined.

If you have the ability to repay some of the CRD before the due date of your 2020 tax return, including extensions, the amount repaid will directly reduce the amount of the CRD that is includible in income on your 2020 tax return, reducing underpayment penalties that otherwise might have already accrued.

It's too late to make an estimated tax payments for 2020 to reduce the amount of underpayment penalty that has already accrued to date, but the sooner you pay your balance due the less additional penalty you'll accrue.  The only reason to make an estimated tax payment for 2020 now would be if you are still not ready to file your 2020 tax return and just pay the balance due.

[bugman-74]

Thanks for the response. I didn't even think about the impact this would have to my 2020 taxes (whoops!). I will plan to pay estimated taxes for 2021 and 2022.

I do not intend to pay back the distribution, and expect to pay the full tax amount (I am spreading out the tax liability over the 3 year period primarily because I expect my 2021 and 2022 tax liability to be significantly less than 2020 - so lower tax bracket).

So my question now is how can I ballpark the the 2020 penalty so I know roughly what to expect that will cost? I withdrew $65k total from 401k, and had federal tax due for 2020 of $7,100.

[dmertz]

TurboTax will calculate the estimated tax penalty and include it on Form 1040 line 38.  Depending on when during the year you received your income (particularly if larger amounts were received late in the year) and any deductions or tax credits, you might find that annualizing your income will reduce the penalty.  Annualizing requires you to identify the amounts of each that were received by the end of each of the tax quarters.  (It can be an onerous task if you do not have detailed records readily available.)

[bugman-74]

1040 Line 38 has no value entered...

For what its worth, the full $65k distribution was received in Nov 2020.

[dmertz]

Make sure that TurboTax has your previous years' tax liability, otherwise it will assume that your previous year's tax liability was zero and may incorrectly determine that you are not subject to any penalty due the the 100% of last year's liability safe harbor.

[bugman-74]

Hmm, interesting. I overpaid in 2019 and received a $600 federal refund. However I also had a 2019 AGI >$150k. Federal income tax withheld was 27,300 and total tax was 26,700. So looks like I didn't quite make the 110% safe harbor threshold... Guess that means I will be getting a bill from IRS.