5 Steps to Eliminate a 2014 Estimated Tax Penalty Before Year-End With Your IRA

By Jeffrey Levine, IRA Technical Expert
Follow Me On Twitter: @IRAGuru4EdSlott

It’s December already, and you’ve just realized that you haven’t been withholding enough income taxes so far this year and/or you haven’t been making the proper quarterly estimated payments in 2014. Does that mean that you’re going to have a penalty? Probably … unless you do something to fix the problem before the end of the year. In most cases, it’s not okay to just pay your tax bill when you file your federal income tax return. Given the fact that we’re now only about a week away from that deadline, there’s generally not much you can do at this point.

Thankfully, however, if you happen to have an IRA, you can take advantage of a nifty trick to reduce, or even eliminate, any estimated tax penalties you might otherwise owe. Here is a step-by-step guide on how to do so:

Step 1: Calculate the amount of tax you should have paid in earlier in 2014, but did not. Remember, you can use 100% (110% if your 2013 AGI (adjusted gross income) was more than $150,000) of your 2013 tax liability as a safe harbor total.

Step 2: Contact your IRA custodian or financial advisor and find out what the distribution procedures are for your IRA. Some of the questions you might consider asking are “What paperwork is needed in order to process my distribution?” and “By what date do you need to receive my paperwork in order to make sure my distribution is processed in 2014.” Chances are they may need the paperwork in before December 31 to process the distribution by that date.

Step 3: Request a distribution from your IRA for the amount of the shortfall you calculated in step 1. Look for the section on your IRA distribution form that covers federal withholding and withhold 100% of your IRA distribution for federal taxes. Doing so will treat your IRA distribution as if it had been paid to Uncle Sam equally throughout 2014.

Step 4: Within 60 days of your distribution, replace the money distributed from your IRA with non-retirement account money. This completes a rollover and keeps your distribution from being taxable. If you end up withholding more than you needed to, don’t worry. You’ll get any excess back when you file your tax return.

Warning: If you’ve made another rollover within the past year (365 days), that may complicate matters. See here for more details.

Step 5: Work with your CPA or other tax professional early in 2015 to set up proper quarterly estimated tax payments for next year. This way, you don’t have to deal with this problem again.

If you follow these steps precisely and in a timely manner, you will avoid owing any taxes on your IRA money sent to the IRS for withholding and you will completely eliminate any 2014 estimated tax penalty you would have otherwise owed.