Avoiding underpayment tax penalties

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Q. 2017 is the first year I am taking a Required Minimum Distribution. It will be $30,000. My 2016 total federal tax was $5,000. If I pay 100 percent of that amount — $5,000 — on my quarterly estimates, will I be okay in not receiving an underpayment penalty? I know my tax bill on April 15 will be huge based on the RMD.
— Planning

A. Here’s the skinny on estimated tax payments.

First, if you owe the IRS $1,000, you must make estimated tax payments or else you will have to pay a penalty, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

If your tax due after withholding is less than $1,000, he said, you can pay it when you file your return with no penalty of interest.

And, Kiely said, if you didn’t have a tax liability for the prior year, then you don’t have to make estimated tax payments in the subsequent year.

Kiely said in any given year, you must pay in the lower of two numbers:

1. 100 percent of your prior year’s tax (110 percent if your prior year’s adjusted gross income was more than $150,000 or $75,000 if you are single).
2. 90 percent of the current year’s tax.

These payments must be through withholdings or estimated tax payments or a combination of the two, Kiely said.

You said your 2016 income tax was $5,000.

“That means you had gross income of about $78,325 if you are over 65 and single. If you already paid in $5,000, you would meet the 100 percent of prior year’s tax rule and avoid an underpayment penalty,” Kiely said.

He said assuming you are single and over 65, the tax on the $30,000 Required Minimum Distribution would be $7,378 — 25 percent times the $30,000. This is on top of your $5,000 of tax from 2016, he said.

“I would recommend that you ask your IRA custodian to withhold 25 percent in federal tax when you make your 2018 Required Minimum Distribution,” he said. “That way you wouldn’t have to worry about making estimated tax payments.”

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This post was first published in December 2017.

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