RMD - Fed Tax Withholding Question

[Jim1Best]

I am completing my 2008 Fed Tax return. Because of "late in the year" RMDs from IRA accounts, I have seriously underpaid this year's tax burden, and, as a consequence, have begun to grapple with next year's Estimated Tax Payment calculations. Any insight, help or opinion from the forum would be helpful.

Setting the Stage: First, I have significant income, other than IRA distributions, which are uniformly spread throughout the year. Second, I would like to postpone all RMDs until late in the year (for tax deferral reasons). And third, I discovered late this year that I have the option to have Federal Tax withheld from the RMD(s).

My question to this forum is:

Is there a reference in the Tax Code which clarifies the options one has in claiming when the tax withheld from a IRA RMD should (can) be credited? Ideally, this may be a way to satisfy the "pay-as-you-go" philosophy of the Tax Code while postponing actually paying the taxes as long as possible. I have found hints on the internet that indicate that RMD withholding amounts are considered by the IRS to be paid in four equal installments on the estimated tax due dates, but have not found one word confirming this in the Tax Code.

If this information is valid, then I pose the additional question as to whether one could eliminate all tax withholding from income throughout the year and use the year-end RMD withholding option to satisfy the quarterly estimated tax payments.

Any answers, facts or opinions are greatly welcomed.


Jim-theDIYguy

[OAG]

You can also have Income Taxes (both Fed and, if applicable State) from any SS benefits you receive. Your RMD payer should furnish you a form that will show the amount of the RMD and, if applicable, taxes withheld. Depending on the level of income you can just pay between 90 and 110% of the Federal taxes due for the prior year (State rules will vary). Or just stay below the $1,000 limit for penalties. You should also just pay estimated taxes through the year (IRS form 1040ES). Publication 17 from the IRS site along with the applicable State Instructions downloaded should help.

[kaneohe]

J1B---I have seen your idea suggested as the ideal way to deal with required withholdings/estimated tax. Withholding, whenever taken, is treated as withheld equally throughout the year (for some reason that makes no sense to me). Therefore withholding late in the year satisfies IRS and also allows you to "earn" as long as possible. If you could satisfy the required amounts by withholding from a late in the year RMD, that would be ideal----you might have to withhold the entire amount .
If that was not enough, you would have to supplement with other withholding (like from SS) or estimated tax. Estimated tax should be paid evenly throughout the year.

[Jim1Best]

Thanks, you guys, for the quick replies and the thoughts. I have further consolidated my thoughts and now am planning along the following lines:

After talking with the IRS help line, I believe that the basic strategy outlined in this thread is sound. The IRS confirmed (I think) that withholding, at any time, from any source, is credited toward your tax liability. Also, if total of the amount withheld is 90% or more of your final tax liability, then no fees or penalties are levied.

With this information, I conclude that I was making it more difficult than necessary in trying to defer tax by paying estimated quarterly amounts - one just needs to arrange to have enough withheld in one lump sum near the end of the year to cover at least 90% of the final tax liability. This also gives another three months deferral for the other 10%.

In the month of December, almost all taxpayers should be able to accurately calculate how much total tax is due for that year. Then having 90% of that amount withheld from the year-end RMD is a lot (and I mean a LOT) simpler than trying to use the Annualized Estimated Tax Calculation Worksheet.

I am going to employ this strategy to convert some of my IRA funds into ROTH accounts early in the year. I know what my RMD is for 2008. Using this amount as 90% of the tax I can pay this year, I will then calculate backwards to see how much AGI I can produce without exceeding the 25% tax bracket; then, subtracting my (predictable) fixed incomes for the year, I can arrive at an amount to convert to ROTH. Come the end of the year, I can elect to have the entire RMD paid to the IRS as withholding. Of course this will leave 10% of the tax to raise from savings during the first quarter of 2009. (In 2009, I won't have this problem because the Bush "tax cuts" permit/allow conversion of IRA to ROTH with the benefit of a two year tax deferral.)

Does anyone have see a fatal flaw in this plan?

Jim-theDIYguy

[kaneohe]

Do you not have mutual funds that declare the bulk of the distributions in Dec?
For me, that's the biggest uncertainty so I wouldn't know early in the year
what to do. Just asking....I haven't tried to learn yet......but are there any
special considerations when you do conversions while taking RMDs?
try fairmark.com or irahelp.com.......I think you know at least one of those
already.

[OAG]

I think you have to look at your tax liability in November as I believe the IRA custodian must make the withdrawal and payment on 1 December yearly (if you do not opt for more frequent payments). I also remember that the amount the custodian can withhold for taxes is either 0% or 20% at the account holders request. IMHO your are making this exercise excessively complicated - I know you are trying to maximize the return but a few months return at even 6% per year on $5,000 would only be about $25 a month and if you happen to miss the target on the low side the penalty for doing so may be greater than you think. I suggest you study IRS 1040ES and the instructions for it closely.