How to figure tax and penalties owed on early IRA distributions?

[taking fire]

Without getting into too many details, I am trying to figure out how to calculate taxes and penalties owed on early distributions of an IRA.

I was employed up until October of last year. My wife is also employed. We receive W2s from those jobs. I came out of work (nice way to say it - not really by choice) and went self employed. I already had a LLC business set up on the side where I did the work that I will do from now on.

I immediately rolled my 401K into my local bank in an IRA. I intended to use this as needed to keep my head above water until I got going good. That has taken longer than expected, but I'm working my tail off and gaining ground.

Any case, I have done my taxes using Turbotax for about ten years. This year, I was not sure of what I might need because of my situation. After talking with Turbotax, they assured me that their self employed version of software will handle everything.

I started doing my taxes a few weeks ago on the online version of Turbotax Self Employed. Everything seems to be going ok, but what I can't find is the area where I list withdrawals or distributions from the IRA. I have not gotten all the way through it, but I was hoping that maybe someone may be familiar with the software and can verify whether or not it actually does this.

My wife actually works for the bank where this IRA and my accounts are, so thankfully I have a pretty clear understanding of what is withheld. The bank is not required to withhold anything, but they recommend at least 10% for taxes. However, this is for anyone, not just people that are under 59.5. She is not sure if there is a difference on taxes that are owed between people making withdrawals after 59.5 or early withdrawals by people under 59.5.

I have been having them withhold 20%. I know that there is also a penalty that will be owed in addition to the taxes. I need to know how to find out the exact amount.

Also, how would this affect me as far as state taxes? I am in Alabama, and I don't know if I owe penalties and taxes on that side as well.

Thanks

[MDM]

The tax on a tIRA withdrawal is the same as the tax on bank interest.  That will depend on your overall tax situation.

The penalty for early withdrawal is 10% of the amount withdrawn.  See Topic No. 557 Additional Tax on Early Distributions.

Don't know for sure about Alabama taxes, but based on Taxes in Alabama I would guess that you will pay normal Alabama tax on the withdrawal amount.

[terran]

The tax on a tIRA withdrawal is the same as the tax on bank interest.  That will depend on your overall tax situation.

Curious why you put it this way? Couldn't it also be said that both interest and IRA withdrawals also taxed at the same rate as earned income?

taking fire, the bank should issue you a 1099R which you should then be able to enter in Turbotax. See https://turbotax.intuit.com/tax-tips/retirement/when-to-use-tax-form-1099-r-distributions-from-pensions-annuities-retirement-etc/L0g2CrvvL. Also https://ttlc.intuit.com/questions/1900628-where-do-i-enter-my-csa-1099-r for the mechanics of actually entering it in Turbotax.

[MDM]

The tax on a tIRA withdrawal is the same as the tax on bank interest.  That will depend on your overall tax situation.

Curious why you put it this way?

Just that no FICA tax is paid on tIRA withdrawals, and it's treated as "ordinary income" as opposed to capital gains.  Of course, there are various wrinkles in the tax code that treat many similar forms of income not identically, so treating a tIRA distribution as a tIRA distribution is best. :)

[taking fire]

The tax on a tIRA withdrawal is the same as the tax on bank interest.  That will depend on your overall tax situation.

Curious why you put it this way? Couldn't it also be said that both interest and IRA withdrawals also taxed at the same rate as earned income?

taking fire, the bank should issue you a 1099R which you should then be able to enter in Turbotax. See https://turbotax.intuit.com/tax-tips/retirement/when-to-use-tax-form-1099-r-distributions-from-pensions-annuities-retirement-etc/L0g2CrvvL. Also https://ttlc.intuit.com/questions/1900628-where-do-i-enter-my-csa-1099-r for the mechanics of actually entering it in Turbotax.

I have the 1099-R from the bank. It basically lists several things, including gross distribution, and federal income tax withheld. I will look closer at the turbotax links you posted. Thank you.

I am really trying to avoid having to go see an accountant. if I can do this on my own, I would much rather do that. I don't want to have to go through the trouble of getting all of my information and life history to an accountant.

[terran]

The tax on a tIRA withdrawal is the same as the tax on bank interest.  That will depend on your overall tax situation.

Curious why you put it this way?

Just that no FICA tax is paid on tIRA withdrawals, and it's treated as "ordinary income" as opposed to capital gains.  Of course, there are various wrinkles in the tax code that treat many similar forms of income not identically, so treating a tIRA distribution as a tIRA distribution is best. :)

Gotcha, good point about interest and IRA distributions not being subject to FICA or self employment tax unlike earned income.

The tax on a tIRA withdrawal is the same as the tax on bank interest.  That will depend on your overall tax situation.

Curious why you put it this way? Couldn't it also be said that both interest and IRA withdrawals also taxed at the same rate as earned income?

taking fire, the bank should issue you a 1099R which you should then be able to enter in Turbotax. See https://turbotax.intuit.com/tax-tips/retirement/when-to-use-tax-form-1099-r-distributions-from-pensions-annuities-retirement-etc/L0g2CrvvL. Also https://ttlc.intuit.com/questions/1900628-where-do-i-enter-my-csa-1099-r for the mechanics of actually entering it in Turbotax.

I have the 1099-R from the bank. It basically lists several things, including gross distribution, and federal income tax withheld. I will look closer at the turbotax links you posted. Thank you.

I am really trying to avoid having to go see an accountant. if I can do this on my own, I would much rather do that. I don't want to have to go through the trouble of getting all of my information and life history to an accountant.

I'm sure you'll be able to figure out how to enter the information from the 1099R in Turbotax. The end result is that you should end up adding the distributions to your income on Line 15b of Form 1040 and the additional 10% penalty/tax for early withdrawal should end up on Line 59 of Form 1040 either after being calculated by multiplying Line 15b by 10% in some cases, or filling out Form 5329 in other circumstances (according the Form 1040 instructions for line 59).

[taking fire]

This may sound like a dumb question, but how do I account for or know what has actually been paid already -the bank's withholding that they send? When I enter everything according to turbotax or instructions on actual tax forms, is it still going to think I need to include that 10%, or will the numbers I have put in reflect that?  Since I actually put in 20%, I'm hoping that it will somehow refund or give me credit if I gave too much.

[MDM]

This may sound like a dumb question, but how do I account for or know what has actually been paid already -the bank's withholding that they send? When I enter everything according to turbotax or instructions on actual tax forms, is it still going to think I need to include that 10%, or will the numbers I have put in reflect that?  Since I actually put in 20%, I'm hoping that it will somehow refund or give me credit if I gave too much.

Withholding goes on line 64 of Form 1040.  See terran's most recent post for where the other items will go.

[ISawTheLight]

When you find the input screen for the 1099-R in TurboTax (I use HRBlock, so I am not as familiar with TT), it should have places to enter all of the information on the 1099-R, including taxable portion, withholding and everything else on the form from the bank.

You should confirm that you do not meet one of the exceptions from penalty - there are a few, including unreimbursed medical expenses, health insurance premiums (if you were drawing unemployment after you 'came out of work'), post secondary education expenses for you or a family member, among others.  It is definitely something to look into, as you may be able to avoid paying the penalty.  In theory, TT will walk you through these questions as part of the return process (again, I'm a HRBlock software user).  You will still pay tax...these are just exceptions from penalties.

You will pay Alabama tax on the distribution, but it does not appear as if Alabama penalizes early withdrawals.

[taking fire]

After entering info from the 1099-R from the bank, It dropped my federal refund by about $300, and also my state for about the same. I can understand the state tax (I think?), but I'm curious still how it works because I don't understand it fully. The federal doesn't make sense though.

For some reason I feel like the federal side isnt right. As stated, if I am only required to withhold 10% for taxes, and I actually withheld 20% to be safe, it would seem like I actually overpaid a little.

The only thing I can think of here is that it is adding the roughly $7k that was withdrawn to my total income (is that gross income?) and then the tax is adjusting that way. My wife and I only made about $66k last year combined, so this would put us at $73K.

[taking fire]

Also, as I continued through the screens, it then told me that it had applied the $700 penalty, which is 10% of the $7k I had early withdrawn. I don't understand this because I input the required information, including the info from box 4 on the 1099-R - which was $1400, or 20% of that amount (the actual tax I already paid).

So now I am wondering how to find out how the bank sends this $1400 to the IRS, and how to account for it. It is almost like TT doesn't realize I have already paid 20% and is trying to deduct an additional 10%.

[terran]

10% of the 20% you withheld is going to pay the penalty, so only the additional 10% is able to go towards paying what you owe on the income from the withdrawals itself. You're probably in the 15% marginal bracket, so that's $7000 x (15% marginal bracket + 10% penalty - 20% withheld) = $350 you owe from the withdrawals over what was withheld.

Withholding and tax owed are not the same thing. Turbotax is telling you it applied the early withdrawal penalty, as it should. When filling out taxes, one calculates the total tax liability, then subtracts the total withheld (Reported on your W2 and 1099R) as well as any estimated taxes paid from the total tax liability to get the total amount still owed. Basically, you owe a certain about of tax no regardless of what you already paid, so you just subtract what you've already paid from the total amount you owe and that's the amount you still owe.

[terran]

Another thing: Just throwing this out there, but are you saying your household income from employment is is $66k and you still felt the need to withdraw $7k for living expenses? You might consider throwing up a post in the case study section of this website and see if you can get some help reducing your spending at least until you're back to your full earning potential. That's more than twice what my wife and I spend in a year and we'd reduce further in a job loss situation, and there are lots of other people with similar or better spending patterns on the forum who could help you take a look at things.

[MDM]

Withholding and tax owed are not the same thing.

It's the answer to many questions, so just in case it was missed in the reply.... :)

[taking fire]

Another thing: Just throwing this out there, but are you saying your household income from employment is is $66k and you still felt the need to withdraw $7k for living expenses? You might consider throwing up a post in the case study section of this website and see if you can get some help reducing your spending at least until you're back to your full earning potential. That's more than twice what my wife and I spend in a year and we'd reduce further in a job loss situation, and there are lots of other people with similar or better spending patterns on the forum who could help you take a look at things.

I have already done a case study thread here, and an update to it as well. Both of those did not go very well, as I learned I am not the best with money. The important thing though is that I am aware of it and I have made small steps to correct and better myself financially over time. This has been one of the most influential websites and blogs I have ever seen.

Yes, what you read was correct. My wife and I have made about $70k annually for probably a decade or so. Last year, I came out of work unexpectedly (polite way to put it) and I already had a side businesses that I basically dabbled in. I had been wanting to go self employed forever, because I cannot stand a job and working for someone else. I decided to go ahead and go after it. I have not made any money really, but my quality of life is immensely better. I had to pull from the IRA to keep us afloat. I have had to do so several times already this year as well. I have nothing to hide. I hope to get the business earning income very soon, because if it does not, I will have used up all of the IRA money and I will have to go back to work. That is something I do not want to do ever again - work another job for someone else.

I am trying to be sure I get every single bit of this tax information right, because if some amount of money ends up being missed and I end up owing the IRS, I'm going to be in a bad spot.

[MDM]

I am trying to be sure I get every single bit of this tax information right, because if some amount of money ends up being missed....

Using TT's input screens can be convenient, but perhaps the best way for you to double check the numbers is to look line by line at form 1040 and match those numbers to what you have on your W-2 and various 1099 forms (and any other tax-related document you have).

[taking fire]

I am trying to be sure I get every single bit of this tax information right, because if some amount of money ends up being missed....

Using TT's input screens can be convenient, but perhaps the best way for you to double check the numbers is to look line by line at form 1040 and match those numbers to what you have on your W-2 and various 1099 forms (and any other tax-related document you have).

Yesterday I started to really wonder, I bet it is not that hard at all to do the tax froms by hand. We don't really have any uncommon situations as far as tax. I bet it would be cheaper too, since TT always seems to sucker us in to paying more than we initially thought we would pay anyway. I always just considered it a necessary evil to something we had to do. After watching a few youtube videos on the forms, I am starting to rethink that.

[terran]

I did mine by hand this year, and you're right it's not hard, and was a great learning experience, but you do need to be careful, methodical, read the instructions. I think the most likely place to mess up is not following the instructions to attach another form. Everything flows to form 1040, but many lines require you to fill out and attach another form, so you could definitely miss one if you're not careful. My advice would be to at least still complete your taxes in one of the big software company products and make sure your "answer" matches theirs, and if not figure out why.