Taxes penalties on early Ira distribution.

[jcreynolds183]

I am considering taking an early distribution on one of my IRA accounts. I understand it will be taxed at my normal tax rate, and there will be a 10% penalty. However, in the process of withdrawing the money from Fidelity, it says “You may be responsible for estimated tax payments and could incur penalties if your estimated tax payments are not sufficient.” My question is, if I make the withdrawal in January, do I have until April 15th of the following year to clear up the taxes with the IRS?

Or, does that quote that I copied above imply that there could be *additional* taxes/penalties to pay if I don’t have Fidelity withhold the funds up front and/or I don’t make an immediate payment (not even sure how that would work) to the IRS? 
basically, do I have all of my withdrawals for over a year before I simply need to clear up the taxes (at my standard income tax rate) and the 10% penalty?  

[Opus 17 · Accepted solution]

The tax system is pay-as-you go, and if you don't pay enough into the system during the year (2023, in your case), then you can be assessed a penalty for underpayment, even if you pay in full when you file your tax return in 2024.  

There is likely a mandatory 10% withholding, but your actual tax is likely to be 22%-32% federal plus 5%-13% for state, depending on your income and your state.   You can satisfy the requirement to pay as you go by either increasing the withholding on the withdrawal or by making an estimated tax payment.  If you have a lump sum of income in January 2023 (for any reason, not just an IRA withdrawal) you are required to make an estimated tax payment before April 15, 2023 (or have extra withholding at the time of the withdrawal).  The actual tax due is calculated on your 2023 tax return that you will file in 2024 (on or before April 15, 2024).  If you under-paid your estimate, you will owe more tax, and if you overpaid your estimate, the excess will come back to you as a refund.

To avoid a penalty for underpayment, your 2023 tax payments (from withholding and estimated payments) must meet one of these three tests:

a. you pay enough so that you owe less than $1000 when you file your return

b. your payments are at least equal to 90% of your current year tax liability

c. your payments are at least equal to 100% of the previous years tax liability (or 110% of the previous year's tax liability for high income taxpayers).

Your tax liability is what the government kept last year.  So if you had $4000 of withholding and paid an additional $1000, your tax liability was $5000.  Likewise, if you had $6000 of withholding and got a $1000 refund, your liability was $5000. 

[jcreynolds183]

Thank you very much; this is helpful! 

A question for clarification… 

In the event that in 2023 I pay via weekly paycheck withholding as much (or more) income tax as I did in 2022, does that satisfy requirement “C” and mean that I will not need to deal with the estimated payment on April 15, nor worry about underpayment penalties?  Or is that 100% of last year’s taxes figure something that’s paid *in addition to* my weekly paycheck withholdings? 

Just trying to make sure I’m understanding that properly. 

[Opus 17]

---

@jcreynolds183 wrote:

Thank you very much; this is helpful! 

A question for clarification… 

In the event that in 2023 I pay via weekly paycheck withholding as much (or more) income tax as I did in 2022, does that satisfy requirement “C” and mean that I will not need to deal with the estimated payment on April 15, nor worry about underpayment penalties?  Or is that 100% of last year’s taxes figure something that’s paid *in addition to* my weekly paycheck withholdings? 

Just trying to make sure I’m understanding that properly. 

---

If your income including the withdrawal will be more than $150,000, then you need to pay into the system an amount equal to 110% of your 2022 taxes, not just 100% of your 2022 taxes.

If you can accomplish that via withholding alone, you should avoid the underpayment penalty without having to make a separate estimated payment.  

[VolvoGirl]

If later you decide you need to pay in some more you can make an Estimated payment directly on the IRS website. Be sure to pick 2023 1040ES payment
https://www.irs.gov/payments

[jcreynolds183]

Per the clarification I received above, it looks like I would need to hit the 110% mark, and I don’t expect I’d accomplish that by my weekly paycheck withholdings as my normal income should be approximately equal to the prior year.  

Would I then need to simply make a payment of roughly 10% more than last year’s withholdings, using the link you shared - and then square up everything else in April of 2024?

[Opus 17]

---

@jcreynolds183 wrote:

Per the clarification I received above, it looks like I would need to hit the 110% mark, and I don’t expect I’d accomplish that by my weekly paycheck withholdings as my normal income should be approximately equal to the prior year.  

Would I then need to simply make a payment of roughly 10% more than last year’s withholdings, using the link you shared - and then square up everything else in April of 2024?

---

Yes, that should work.

Be aware, of course, that doesn't save the tax, just the extra penalty.  After paying 10%, you will still need to set aside another 30% or so in a safe place.  

[rjs]

---

@jcreynolds183 wrote:

Per the clarification I received above, it looks like I would need to hit the 110% mark, and I don’t expect I’d accomplish that by my weekly paycheck withholdings as my normal income should be approximately equal to the prior year.  

---

Instead of making estimated tax payments, you could give your employer a new W-4 to increase your withholding. After you get your first paycheck in 2023 you can use the Tax Withholding Estimator on the IRS web site to figure out what to put on your W-4 form. Don't forget to change it back at the beginning of 2024.

[jcreynolds183]

Do you happen to know how this works with Michigan state taxes?
Would they have the same 110% of last year’s taxable income rule?