December 10, 2019
- Underpayment Penalties
- Under-distribution Penalty
- Required Minimum Distributions
- IRA-to-Charity Distributions
The holiday season is upon us, complete with family gatherings, over-indulging in food and beverages, and gift shopping and giving, and the last thing most of us want to think about right now is what faces us after the New Year is rung in: tax season! But taking some time now to get in the tax-season spirit may help you to avoid or reduce certain penalties on your 2019 tax return.
Underpayment Penalty – Have you prepaid enough taxes to cover your 2019 liability? If you are an employee, you will have had income tax withheld from your paychecks, but has that withholding been sufficient? This is an especially important question if you have a second job or a side business, or if you are married and your spouse is also employed. Many times in these circumstances, your withholding for the year may not be enough to cover your 2019 tax liability. Further complicating the issue is that many individuals still haven’t adjusted their withholding with their employers to account for the numerous tax reform changes, which mostly became effective starting in 2018.
You will be hit with an underpayment penalty if your advance payments toward your 2019 tax liability, through withholding and estimated tax payments, are less than 90% of your 2019 tax or 100% (110% for high-income taxpayers) of your 2018 tax. But the good news is there is no penalty if you owe less than $1,000 in tax.
When the underpayment penalty does apply, it is figured on a quarterly basis, so making an estimated tax payment late in the year will not reduce the penalties from earlier periods. However, wage withholding is treated as being paid evenly throughout the year, allowing you to mitigate underpayments earlier in the year by increasing your withholding late in the year. Does your state have an income tax? If so, then also be sure to adjust your state income tax withholding, if needed, to offset under-withholding earlier in the year to avoid or reduce a state underpayment penalty.
Under-Distribution Penalty – Tax law doesn’t allow money to indefinitely remain untaxed in your traditional IRA, a self-employed retirement plan, or your employer’s qualified plan. Thus, you are required to annually withdraw a minimum amount from the IRA or plan (referred to as the minimum required distribution or RMD) once you reach 70 1/2 years of age*. Did you turn age 70 1/2 in 2019 or reach 70 1/2 in an earlier year? If so, and if you haven’t already, be sure to take your RMD for 2019 or face a potential penalty (additional tax) equal to a whopping 50% of the amount you should have withdrawn for 2019.
The minimum distribution for any year is based upon an annuity factor for your age divided into your account balance on December 31 of the prior year. Most IRA custodians or trustees will advise their clients of the RMD for the specific accounts they oversee, but if you need help figuring out your RMD amount, especially if you have multiple accounts, please call this office for assistance.
With one exception (see next paragraph), when you are required to make an RMD, you must withdraw the funds for the year from your traditional IRA or a qualified plan by December 31. While there’s no penalty for withdrawing more than the minimum required amount, you can’t use the excess withdrawal as a credit toward the next year’s required distribution.
Delayed First-Year Distribution – A special rule allows you to delay your first RMD, for the year when you turn 70 1/2, until the first quarter of the next year. This means if you became 70 1/2 in 2019, you could delay your 2019 withdrawal until no later than April 1, 2020. But if you do that, you will have two years’ worth of distributions to include in your 2020 income because you must still take your 2020 RMD by December 31, 2020. Delaying the 2019 distribution may or may not be beneficial taxwise, depending on your tax bracket for each year. If 2019 was your retirement year, then your income tax bracket may be higher than it will be for 2020, so in that case, delaying the 2019 distribution until 2020 may make tax sense.
Special IRA-to-Charity Provision – A special provision applies to taxpayers age 70 1/2 and older who directly transfer up to $100,000 a year from their IRA to a qualified charity. If you are 70 1/2 or older and make an IRA-to-charity transfer, you won’t get a charity deduction for the amount transferred; instead—and even better—you will not have to pay taxes on the distribution, and because your adjusted gross income (AGI) will be lower, you can benefit from other tax provisions that are pegged to AGI, such as the amount of taxable Social Security income and the cost of Medicare B insurance premiums for higher-income taxpayers. As an additional bonus, the transfer also counts toward your annual RMD. You can make the IRA charitable distribution to multiple charities, but the $100,000 yearly limit applies in total and not to each charity. Contact your IRA trustee to initiate the transfer, which must be done by December 31 to count for 2019. In addition, for each qualified charitable distribution, you need to obtain an acknowledgment for it from the charitable organization.
If you have questions about making up withholding shortfalls or retirement distributions as they relate to your particular circumstances, please contact us.
*Exception: Distributions from qualified plans such as 401(k)s, but not IRAs, do not have to begin until the year of retirement.