Question regarding tax withholding

[Purron]

My husband and I had lots of changes to our finances last year including me claiming social security. As a result of these changes, we didn’t have enough withheld and had modest underpayment penalties from the Feds and Commonwealth of Virginia. We’d like to avoid penalties next year. Our income is primarily from pensions, social security, and investments. What’s the best way to prepay taxes to the Feds and Virginia to avoid future penalties? Looked at the options from the IRS and Virginia and are not sure of the best way to proceed. We could increase withholdings from one of our income streams, set up a payment automatically from our checking, or just send in advance payments. Perhaps we’re missing another option. What say the experts around here?

 

[audreyh1]

There is something called safe harbor to avoid penalties for Federal taxes. As long as your withholding and estimated taxes match the taxes owed for the prior year (or prior year times 1.1 if income exceeded $150K) you won’t owe a penalty for underpayment even if taxes owed way exceed the prior years taxes. This needs to be paid in 4 equal installments of estimated taxes on the IRS quarterly estimated tax due dates, or if you can pay via withholding you have more flexibility and just need to have the amount withheld for taxes by the end of the year.

I don’t have tax withholding available so we pay estimated taxes via eftps.gov which lets us schedule tax payments as ACH withdrawals.

 

[Souschef]

For the Feds I use EFTPS and have quarterly estimated tax payments taken out of my checking account. You set up the dates and the amounts.

In CA they have a similar scheme. I do not know, but expect your state might have a similar program.

 

[SecondCor521]

There is something called safe harbor to avoid penalties for Federal taxes. As long as your withholding and estimated taxes match the taxes owed for the prior year (or prior year times 1.1 if income exceeded $150K) you won’t owe a penalty for underpayment even if taxes owed way exceed the prior years taxes. This needs to be paid in 4 equal installments of estimated taxes on the IRS quarterly estimated tax due dates, or if you can pay via withholding you have more flexibility and just need to have the amount withheld for taxes by the end of the year.

I don’t have tax withholding available so we pay estimated taxes via eftps.gov which lets us schedule tax payments as ACH withdrawals.

@audreyh1, I assume that if one pays an amount equal to prior year's taxes owed by the first quarterly estimated date then one is also fine?

For example, I help with a trust that owed say $1500 in taxes for 2018. If the trust pays in $1600 by 4/15/19 for 2019 estimated, it should not be subject to underpayment penalties, right?

Obviously wouldn't do that if cash flow were a problem, but in this case it isn't.

(Seems easier to do in one fell swoop rather than sending in four checks on four different dates this year.)

...

@OP, some people do a withdrawal from their IRA near the end of the year and elect 99% withholding. This works well if the withdrawal is qualified and the additional income (if withdrawing from a traditional IRA) doesn't change the tax picture too much.

 

[audreyh1]

Sure, you can pay ahead.

 

[VanWinkle]

My husband and I had lots of changes to our finances last year including me claiming social security. As a result of these changes, we didn’t have enough withheld and had modest underpayment penalties from the Feds and Commonwealth of Virginia. We’d like to avoid penalties next year. Our income is primarily from pensions, social security, and investments. What’s the best way to prepay taxes to the Feds and Virginia to avoid future penalties? Looked at the options from the IRS and Virginia and are not sure of the best way to proceed. We could increase withholdings from one of our income streams, set up a payment automatically from our checking, or just send in advance payments. Perhaps we’re missing another option. What say the experts around here?

You can set up withholding on your pension or SS checks to match your withholding liability. Your tax preparer should be able to assist you on how much you need to have withheld.

 

[Lakedog]

I do all withholding from fed pension as that is very simple and requires no extra effort to setup. Seems that withholding from pension or SS would be the easy way.

 

[RunningBum]

VA has an online payment system and other options that can be found here:
https://tax.virginia.gov/individual-income-tax-payment-options

 

[donheff]

I do all withholding from fed pension as that is very simple and requires no extra effort to setup. Seems that withholding from pension or SS would be the easy way.

Ditto. I adjust the amount in April to be sure I am within the safe harbor for the current year.

 

[mrfeh]

For the Feds I use EFTPS and have quarterly estimated tax payments taken out of my checking account. You set up the dates and the amounts.

In CA they have a similar scheme. I do not know, but expect your state might have a similar program.

+1

Pay quarterly estimated taxes.

 

[RetireBy90]

We are in the middle of a similar situation, retired last year so had W2. Company paid for unused vacation and also sent a check for 2/3 of my 2018 bonus that would have been paid in 2019 but they sent it in 2018. So I had a couple extra checks from company. We also have 3 small pension checks so 4 incomes that makes tax rate higher than any of the individual sources of income.



So this year I have a plan to draw my spending above the pension checks from my TIRA and have 22% withheld. Then there are the tax changes for 2018 tax year, and we will file with standard deduction that is less than our itemized deduction from 2017 and before. However, we also will start one SS check in June so finances won't be settled down till 2020 taxes in 2021. Not that we can't deal with it but seems that there is a lot of work to let VA and Feds take a cut. I'm planning on a final end of year draw from IRA with 99% withholding to add any needed tax payments. Read about that on this site earlier. Hope that works out better than 2018 taxes.

 

[SumDay]

There was an article in the WSJ in June that said "...the IRS often waives estimated tax penalties incurred in the year someone retires or becomes disabled, or sometimes the year after that. To qualify, the taxpayer submits Form 2210 with proof and an explanation that the error wasn't willful. But, this relief often comes after a scary letter from the IRS and filling out yet another form - so avoid it is you can."

I printed this off last summer as I was going to retire in two months and thought we might be in this position. Hope this helps.

 

[ChrisC]

I do all withholding from fed pension as that is very simple and requires no extra effort to setup. Seems that withholding from pension or SS would be the easy way.

Double ditto, but if you're doing large scale Roth Conversions, this might not even be enough. Safe harbor does have its limits even when withholding from your Federal pension.

 

[Purron]

Thanks for the suggestions everyone!

 

[audreyh1]

Double ditto, but if you're doing large scale Roth Conversions, this might not even be enough. Safe harbor does have its limits even when withholding from your Federal pension.

What do you mean safe harbor has its limits?

As long as you pay the prior year’s taxes (or prior year’s taxes times 1.1 if your prior year income exceeded $150K), and you pay within the correct timeframes for estimated tax payments, or you have the amount withheld by the end of the tax year, you will not owe a Federal tax penalty even if your income and taxes jump an enormous amount.

So it makes absolutely no difference if you suddenly make a large scale Roth conversion.

 

[SecondCor521]

Just guessing what @ChrisC meant (because I lack boundaries and think I understand others better than most ):

There are (as I'm pretty sure @audreyh1 knows) at least three different safe harbors. Meet any one of them and you won't pay underpayment penalties.

The one audreyh1 mentions is how much one pays compared to the amount of prior year taxes. As she correctly points out, this is a good one because even if your income jumps, you still won't pay an underpayment penalty.

Another one, which may be the one ChrisC is thinking of, is that if you pay at least 90% of the current year's taxes then you're also OK. Obviously, if your current year tax liability jumps due to a large Roth conversion, then it may be harder to meet this safe harbor. This one does help, though, if one's income drops year over year.

A third one, I think, is if you owe less than $1,000. I don't think this one gets much use, but it does (or at least used to) exist.

(A fourth one - and I'm not sure if this is technically a safe harbor or not - is if you didn't owe taxes in the prior year. Then you can underpay the current year by any amount and be OK, at least that is my understanding.)

 

[ChrisC]

What do you mean safe harbor has its limits?

As long as you pay the prior year’s taxes (or prior year’s taxes times 1.1 if your prior year income exceeded $150K), and you pay within the correct timeframes for estimated tax payments, or you have the amount withheld by the end of the tax year, you will not owe a Federal tax penalty even if your income and taxes jump an enormous amount.

So it makes absolutely no difference if you suddenly make a large scale Roth conversion.

Well, yes, you could be good for the year in which you meet the safe harbor limits of 110% of tax liability for the prior year, but my point is with large conversions during that year this would make the safe harbor level for the succeeding tax year very difficult to meet by mere taxwithholding. Say you calculate your safe harbor level to be $40K in 2018 (but you did $200K in Roth conversions in 2018 so that your safe harbor level is now $85K for 2019). If you're on a Federal pension and the most you can reasonably withhold for 2019 is $60K, then you have to make estimated payments for the difference or withhold from the conversions.

 

[ivinsfan]

There was an article in the WSJ in June that said "...the IRS often waives estimated tax penalties incurred in the year someone retires or becomes disabled, or sometimes the year after that. To qualify, the taxpayer submits Form 2210 with proof and an explanation that the error wasn't willful. But, this relief often comes after a scary letter from the IRS and filling out yet another form - so avoid it is you can."

I printed this off last summer as I was going to retire in two months and thought we might be in this position. Hope this helps.

What scary letter, if you owe underpayment penalties or interest don't they show up and get included when you filed your return? It's stuff like this that makes me wary of any mainstream finance article.

 

[Souschef]

What scary letter, if you owe underpayment penalties or interest don't they show up and get included when you filed your return? It's stuff like this that makes me wary of any mainstream finance article.

I agree. I had a lot of LTCG's from funds I had not counted on. My TT software calculated the penalties as $9 federal and $3 state.It was not enough to worry about and file a 2210.

 

[skipro33]

I do all withholding from fed pension as that is very simple and requires no extra effort to setup. Seems that withholding from pension or SS would be the easy way.

Exactly. Very easy for me to login and make a change on my pension tax deductions at any time. It is also easy to withhold federal tax from SS, but not as easy as through pension. SS requires you to print out form W-4V
https://www.irs.gov/pub/irs-pdf/fw4v.pdf
and drop it off at your local SS office. No appointment needed, there is a mail slot to just drop it in. The form allows you to select 7, 10, 12 or 22%.
This form does not withhold for state income taxes, but then Virginia, like California where I live, doesn't tax SS. If you were short on state income taxes to the tune of paying a penalty, I'd say the easiest method would be through your pension.

 

[statsman]

I do all withholding from fed pension as that is very simple and requires no extra effort to setup. Seems that withholding from pension or SS would be the easy way.

This is our first full year in retirement where we're doing pretty much this. We do have a small (less than $100k) inherited IRA where we take the RMD in December. If I find we're a little short of our withholding goal as we get toward the end of the year, we can always withhold from the RMD. Doing the latter is easier than constantly changing the withholding on our pension. Submit the request too late in the month for the pension and you don't see the withholding change until two monthly payments later.

 

[audreyh1]

Well, yes, you could be good for the year in which you meet the safe harbor limits of 110% of tax liability for the prior year, but my point is with large conversions during that year this would make the safe harbor level for the succeeding tax year very difficult to meet by mere taxwithholding. Say you calculate your safe harbor level to be $40K in 2018 (but you did $200K in Roth conversions in 2018 so that your safe harbor level is now $85K for 2019). If you're on a Federal pension and the most you can reasonably withhold for 2019 is $60K, then you have to make estimated payments for the difference or withhold from the conversions.

Well, you just have to be very careful the next year if you choose to pay less.

Prior year’s taxes is not the only safe harbor. Payments 90% of current years taxes works too. If you can’t reasonably the predict the current year income, then you still have the annualized income method as an option.

Personally I switch to the annualized income method for estimated taxes after a high taxable income year, paying taxes based on income as it is received during the year. It means I have to file form 2210, but I don’t owe a penalty.

 

[ChrisC]

Well, you just have to be very careful the next year if you choose to pay less.

Prior year’s taxes is not the only safe harbor. Payments 90% of current years taxes works too. If you can’t reasonably the predict the current year income, then you still have the annualized income method as an option.

Personally I switch to the annualized income method for estimated taxes after a high taxable income year, paying taxes based on income as it is received during the year. It means I have to file form 2210, but I don’t owe a penalty.

I seek to be very careful as I do conversions, alternating large conversions in tax years, so on the years in which my conversions are not giant size one, I should have no problem with staying in safe harbor from pension withholdings.

This also helps with not spiking up IRMAA too high in given years.

Nonetheless, when I'm not within safe harbor from pension withholding, I plan to have the trustee of the traditional IRA or 401k withheld 10 or 20 percent from the rollover-conversion and within 60 days pay that withhelod amount to the Roth trustee. I've been advised that withholding from any source -- wages, pensions or distributions/rollovers from retirement accounts -- counts towards safe harbor.

I don't really want to mess with estimated or quarterly tax payments or form 2210.

 

[CardsFan]

I don't really want to mess with estimated or quarterly tax payments or form 2210.

IMHO, withholding is the simplest way to pay my taxes (fed and state). We have no pensions, so I simply estimate taxes in December (after any Roth conversion) and take a draw from my IRA, withholding the proper amount.

When we start SS, we will have withholding taken that should cover all taxes, but I can still add at the end of the year, if I miscalculated.

When RMD's kick in, we will just withhold from them as well.

 

[Cobra9777]

We don't have any withholding. DW and I both have pensions, but we elected no withholding. We also have rental income and dividends from a taxable account. No SS or RMDs yet. Our taxes are "all over the map" since I retired. First couple years, I was still exercising employee stock options. DW decided to keep working a few more years. Then we both retired and sold some rental properties. Plus, we usually have a large Roth conversion in December and often tax loss harvesting opportunities. After 5 years of retirement, 2018 was the first somewhat "normal" year, but the tax law changes introduced some new variables for us like QBI and possible conversions into the 22% bracket.

For us, it's easier to manage all these moving pieces with quarterly estimates and the annualized income method. Plus, as I've posted before, I like to pay the IRS the least amount possible at the last possible moment, while carefully avoiding penalties for under-withholding. It's just a little game that keeps me amused.