If you realize close to the end of the year that you are going to face a penalty for insufficient payments of estimated tax, there are two ways out of the situation. But you must act before the end of the tax year -- once you are into the next year it is too late.
- Increase your withholding tax payments. The law presumes that withholding tax is spread equally over the year, even if the reality is that you paid most of it in December. Go to your employer and change your exemptions on your W-4 form to zero to increase the amount withheld. You can change it back with a new W-4 form later. The number of exemptions you claim on the W-4 has nothing to do with the number of exemptions you claim on your tax return. The W-4 is simply used by the employer to establish a withholding rate -- which is supposed to be close to your actual tax liability for the year.
- If the situation is really desperate, but you can come up with the cash within 60 days, a pension plan rollover may save you. With the 20% withholding tax on pension plan rollovers effective January 1, 1993, this technique is brand new. What you do is take enough money out of your plan to have the 20% withholding tax be sufficiently large to cover your tax prepayment shortage. It counts towards your total withholding for the year when you do your tax return. And as long as you pay the pension plan withdrawal (including the 20% that was withheld) into a new plan within 60 days, there is no tax penalty. So what you have is a loan of the withheld money to cover your underpayment penalty. Obviously you may lose a bit of interest on the pension plan with this transaction, but that is going to be a whole lot less than the penalty for underpaying your estimated tax. Just be sure you get the full amount of the money back into a pension plan within 60 days, or you are going to have a much worse problem than the one you started with, because you will then pay income tax on the entire withdrawal and a 10% premature distribution penalty.
About the Author Adam Starchild is the author of numerous books and articles on tax planning and related subjects.Copyright © 1993, 1995, 1997 by Adam Starchild
The Tax Library has reprinted this copyrighted article with the permission of the author.
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