Federal law requires that taxpayers must pay their income taxes throughout the year as they earn income. You can’t just write one big check every April for what you owe from the entire previous tax year when you file your income tax. This obligation may be met through withholding, making quarterly estimated tax payments, or both. The taxpayer will be subject to a penalty, in most cases, unless these payments equal 90 percent of your 2010 tax liability or 100% of your 2009 tax liability. Taxpayers should review the amount of withholding currently being taken by their employers to avoid having to pay the underpayment penalties (and interest) for future years. There may be several additional ways to help deal with this issue to avoid these extra penalties. Here’s just one idea.
Advanced Planning Tip
If you anticipate being liable for underpayment penalties on estimated tax, you may consider taking an ‘indirect rollover distribution’ from a traditional or Roth IRA account during the year of underpayment. If an indirect rollover of an IRA occurs, the trustee of the IRA is required to withhold 20 percent of the funds distributed as a prepayment of federal income tax unless you elect not have federal taxes withheld on Form W-4P. You may also elect to have an additional amount withheld from this distribution by providing the trustee of the IRA with Form W-4P. By triggering sufficient withholding tax, you can cure prior underpayments of estimated tax and avoid or reduce penalties. As long as you re-deposit the gross amount of the IRA distribution to another IRA within 60 days, no adverse tax consequences result from the rollover, provided you meet the once-per-year rollover limitation.
Contact your tax attorney or CPA today to get additional details on whether this planning idea is right for you.
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