Tax Strategies & Credits

Year-End Tips to Avoid Tax Penalties for Withholding Underpayment or IRA Distributions

11/8/2017

If you looked at the calendar and were stunned at how quickly November has rolled around, you’re not alone – this year has flown by. If you’re like the rest of us, you’re probably busying yourself with holiday preparations and gift purchases. But there are other things you need to be focusing on, including getting ready to file your 2017 tax return.

Everybody’s tax situation is different, but for most people it makes sense to take a few steps in preparation for filing to make sure that you minimize your tax burden and cut the risk of having to pay fines or penalties for things you should have done, or things you didn’t take care of in a timely manner.

Underpayment Penalty

We all rely on our employers to take out the correct amount of withholding from our wages, but that isn’t always the case. Meeting your tax burden is your responsibility – not your employers – and when a mistake is made, it is you that is responsible not them. The same is true for those whose employers take out the correct amount of withholding for their job, but who have also taken on additional job responsibilities such as a part-time job. The more taxable income you make, whether from additional work or from investments, the more you are supposed to pay the government throughout the year. And failure to do so can be cause for a second look from the government.

We are all responsible for sending in the taxes that we owe on our earnings. Self-employed people are supposed to pay estimated tax payments and people who are employed are obligated to make sure that their workplace is withholding the correct amount. If the amount that is paid is less than 90% of the correct 2017 tax liability or 100% of your 2016 tax liability (if you are a high-income taxpayer, that percentage rises to 110%), then you are on the hook for a penalty for underpayment, unless the amount owed is under $1,000.

If you are subject to an underpayment penalty, you need to understand that the calculation is done per quarter: paying late doesn’t eliminate penalties that were incurred earlier in the year, but if the underpayment is specifically related to wages that were not withheld, you’re in better shape because the assumption is that withholding is paid in appropriate even payments all year long: that means that you can pay more at the end to make up for the earlier underpayment.

If you do find that you have underpaid your federal taxes, make sure that you also make corrections to the income tax you owe to your state to avoid paying penalties to them as well.

Penalty for Under-Distribution

If you have a traditional IRA or similar qualified plan, you are expected to eventually move the money out of the fund so that you can pay appropriate taxes. To accomplish this, the government has created laws that require taxpayers who have reached the age of 70½ to begin taking out money every year (except for funds from 401Ks). There is a required percentage that needs to be taken out, referred to as Required Minimum Distributions or RMDs. Failure to do so is met with a penalty of half of what should have been taken out, and that amount is based on a calculation that takes into account your age and the amount of money in the IRA or account on the last day of the previous tax year. You are certainly allowed to take out more than the calculated minimum, but doing so does not mean that you can apply the extra to the amount that you are required to take out for the next tax year’s RMD.

Delayed First-Year Distribution

There is a specific allowance that is provided during the year you turn 70½, the first year that you’re required to withdraw the Required Minimum Distribution, that allows you to hold back on your first withdrawal. This special rule means that you can wait until the end of the first quarter of the year following the year you hit the requisite age before you take the distribution, but it’s important to remember that doing so does not eliminate your requirement for the following year. You will end up having to take the RMD for the previous year and the tax year in which the distribution is taken, and this may or may not provide you with a tax benefit. The best way to determine which works best for you is to check with your tax professional, though in most cases taking the distribution during a year that you are working will result in a higher tax hit – it may make sense to wait if you are planning a retirement.

Special IRA-to-Charity Provision

For taxpayers who are 70 ½ or older, IRS rules allow a direct transfer from an IRA to a qualified charity. This transfer can be for up to $100,000 per year, and rather than providing a charitable deduction it provides the ability to avoid taxation on the amount that is contributed, as well as on the distribution itself. Doing this effectively lowers your adjusted gross income, which means that it lowers your taxable income, and this can have a domino effect on other taxes you owe, such as on Social Security income, Medicare B insurance premiums if you qualify as a high-income taxpayer, and the contribution even counts towards your required minimum distribution.

Understanding the rules and regulations that surround required minimum distributions and underpayments is a challenge, so make sure that you have spoken to your tax professional to make sure that you are complying with all rules and meeting all appropriate deadlines.

Spencer Wilson writes for TaxBuzz, a tax news and advice website. Reach him at [email protected].

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Spencer Wilson

Spencer Wilson, EA is a tax preparer based in Long Beach, CA. Spencer Wilson Financial Management Services has been serving the Greater Los Angeles Area and Orange County since 2004. <br /> We began in the heart of Naples in Long Beach and we continue to work hard offering tax preparation and planning, business accounting and bookkeeping and payroll services . <br /> We have helped many different people and businesses succeed financially and take control over their finances.

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By utilizing TaxBuzz Ai, you acknowledge and agree that the information generated should not be considered as a substitute for professional advice tailored to your specific circumstances. We explicitly disclaim any liability for the consequences arising from the use of advice generated by TaxBuzz Ai. Users are encouraged to independently verify the information and seek professional advice before making decisions based on the Ai-generated responses.

Usage Guidelines:
- Professional Judgment: TaxBuzz Ai is a tool to aid tax professionals in research and analysis. It is not a replacement for professional judgment, and users should exercise their expertise when interpreting and applying the information generated.
- Consultation with Experts: While TaxBuzz Ai provides valuable insights, it is crucial to consult with legal and tax experts to ensure the advice aligns with the latest legal developments and specific nuances of a particular situation.
- Verification of Information: Users are responsible for independently verifying the information provided by TaxBuzz Ai, especially in instances where the advice generated is critical to decision-making.
- Educational Purposes: TaxBuzz Ai is intended for educational and informational purposes only. It is not intended to provide specific legal or tax advice tailored to individual circumstances.
- Non-Endorsement: The use of TaxBuzz Ai does not constitute an endorsement or guarantee of the accuracy of the information provided. Users are encouraged to corroborate the advice with other reliable sources.
By accessing and using TaxBuzz Ai, you agree to abide by these terms and acknowledge the limitations outlined herein. We reserve the right to modify these terms at any time, and your continued use of TaxBuzz Ai constitutes acceptance of any such modifications. If you do not agree with these terms, please refrain from using TaxBuzz Ai.

TaxBuzz.com is a service of CountingWorks, Inc., 2549 Eastbuff Drive., #448 208, Newport Beach, CA 92660

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