U.S. tax law requires payment of income taxes contemporaneously to when the income is earned. This means as you earn money, you should be paying taxes on those earnings. This is true for all types of income: wages, self-employment income, distributions from retirement plans, dividends, interest and on and on. Not meeting this obligation to pay taxes as income is earned can result in penalties when a tax return is filed.
For many people, this requirement is easily met during their earning years through the withholding system. Income taxes are withheld on paychecks, and that’s that. Self-employed individuals and retirees, however, are left to make tax payments on their own using the quarterly estimated tax payment system. This system allows for payment of taxes on income earned in four installments throughout the year, and satisfies the requirement to pay taxes as income is earned so long as enough tax is paid.
However, there is another method which is often overlooked. For individuals receiving IRA distributions taxes can be withheld directly from the these distributions. What’s more, this does not have to occur during the entire year. An individual could simply direct a final IRA distribution in December for the entire amount of estimated tax due for the year and direct that 100% be withheld. No quarterly payments required. No need to pay taxes throughout the year. One simple payment late in the year when tax liability can be more easily and accurately estimated. That’s it. This method can be particularly suitable for individuals subject to required minimum distributions from IRAs.
Monthly Planning Tip: Consider using the IRA tax withholding system as a method to simplify estimated tax payments.
It is important to note that this final IRA distribution if from a traditional IRA would be considered a taxable distribution despite the entire amount going to the IRS and possibly a state taxing authority. The total tax liability should be adjusted to include the distribution as taxable income.