LEGAL METHODS TO PAY FEDERAL ESTIMATED TAXES ANNUALLY

Submitted by Alan Durfee on Sat, 2020-06-06 17:11

I am retired, past 72 years of age, and instead of paying estimated quarterly taxes via Form 1040-ES, I have been satisfying my annual estimated income tax requirements by taking my RMD ( TIRA account ) and requesting that the custodian withhold a percentage from that RMD to pay my estimated taxes for the year.

The custodian obliges by sending the designated amount to the IRS and issuing a 1099-R to me.

Can you provide the legal basis and some references for my using that method to pay my yearly estimated tax in lieu of using Form 1040ES to pay quarterly estimates ?

Can the same thing be done using post-tax money instead of being withheld from a portion of my RMD?

Thank you

AlanD



Submitted by Alan - IRA critic on Sat, 2020-06-06 18:36

  • Sec 3405 outlines the withholding rules for pensions, annuities, and other tax deferred accounts. The default rate is 10%   for non periodic payments, but the taxpayer can decline withholding altogether, or opt for another % of their choice. Must custodians support withholding elections from 11 to 99% of the distribution. Therefore, the method you are using is completely legal and quite popular because unlike quarterly estimates, withholding is treated as being paid equally throughout the year regardless of when in the year the distribution is made. Therefore, as long as the total withholding amount is sufficient to meet one of the safe harbors for the year, the distribution can be done in December and the withheld amount is treated as if paid equally. 
  • While withholding on dividends and interest is normally done only when actually required (eg backup withholding), you can check with your brokerage firm or bank if you are interested in voluntary withholding from these income sources, and if offered, establish the % you want.
  • If your RMD is large enough to use withholding during RMD years, you can probably avoid quarterly estimates. But 2020 is unique due to the RMD waiver. Now that it’s halfway through the year, you may need to determine whether to set up an EFTPS account to pay your 2020 taxes from your savings, even though you may not need it again. Another possibility is withholding from your SS income, but administrative delays with that may be a concern. If you get a pension you can also establish withholding from the pension for the rest of the year, and then stop it after the December payment.
  • Of course, you could still take a 2020 IRA distribution and have 99% withheld, but this withholding distribution will itself be taxable and further increase your 2020 taxes. Some people are converting the amount that WOULD HAVE been their 2020 RMD, resulting in the same tax bill they would have had, but reducing future RMDs by reducing the TIRA balance. You then would have to figure out how to pay those taxes.
  • If your taxable income in 2020 will be far lower due to no RMD, and you do not convert perhaps your total taxes will be low enough to just ignore the small underpayment penalty. 

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