tax ? Thrift Savings Plan Early Withdrawl

[Purseval]

My sister is trying to do her taxes using Turbo Tax and it is saying she owes $40,000 Apparently they withdrew money early from a Thrift Savings Plan to buy a house. They paid a 10% penalty when they withdrew it and the rest is being counted as income. Would that be correct or is TT messing up? The entire amount they withdrew went into buying the house. Are they up the proverbial creek?

 

[msmayor]

If they withdrew the money out of a tax-sheltered plan (which a 401(k) is) then it is indeed counted as income ALL in the year it was distributed. This is the regular income tax in addition to the 10% penalty.

When they withdrew the funds, they should have been given the option to have income tax withheld in addition to the penalty. I'm guessing they did not?

It makes no difference that they used the funds to buy a house. They didn't pay the income tax on the money when it was deposited, and now must pay since they withdrew it. The amount is pretty high because a sum like $40K would surely throw them up into one of the higher tax brackets, meaning a large chunk of the $40K is being taxed at a high rate.

Their 1099-R will have all the information on the distribution. Box 1 shows the gross distribution, Box 2a the taxable amount. Generally these numbers are identical. If any income tax was withheld (including the penalty amount) that would be in Box 4.

If only 10% of the total withdrawal is shown in Box 4, or if nothing is shown there, then yes...they are up the proverbial creek if they do not have the money to pay the taxes now due.

 

[Purseval]

Thanks for the quick answer. Yes, they are in big trouble. Her husband was transferred and they needed money for a house. Apparently they thought they paid the taxes when they took the money out but they looked on the 1099 and it looks like they just paid the penalty. Big time ouch

 

[msmayor]

I might have mis-worded my original response, thinking they only withdrew $40k. You're saying the tax bill is $40K?

They must have withdrawn a very large amount; over 6-figures.

 

[Purseval]

$130,000 They worked overseas in a government job for many years and they asked for the penalty and taxes to be taken out. Apparently only the former was, now they'll just have to deal with it.

 

[msmayor]

Well then $40k in taxes is about right. $13,000 for the penalty, and about 20% on the $130,000 in income for $26,000 equals $39,000.

Strongly...STRONGLY suggest they contact the IRS and arrange a payment plan.

 

[Purseval]

We were just looking into that but when the IRS recommends a bank loan or credit card to save money on penalties and interest an installment plan from them doesn't sound too promising.

 

[msmayor]

Well unless they have $40K sitting somewhere in the bank (and chances are if they withdrew from a 401(k) toward a house, they don't) then regardless of where they get the money its going to cost more because of interest.

Perhaps a home equity loan? That may be the most favorable rate.

 

[Purseval]

They will be able to get the money, first they have to get over the shock. Now that they know TT isn't messed up they will figure out their total tax bill and take it from there. They also have to do their state taxes and I'm hoping that since they just moved into the state they won't get whacked again for an entire year.

 

[maggieusa]

Wow why didn't they just rent first instead of taking that big hit . Thats alot of money to owe

 

[rparmfamily]

Are they active duty? Retired? Civlian employees of the government? Did they completely empty it or did they do a loan instead?

http://www.tsp.gov/
Who can get a TSP loan?
While you are a member of the uniformed services, the TSP loan program gives you access to the money that you have contributed to your TSP account and the earnings on that money. You must be in pay status to obtain a loan, because your regular monthly loan payments are made through payroll deductions.

What types of loans are there?

There are two types of loans — a general purpose loan and a loan for the purchase of your primary residence. You can apply for a general purpose loan with a repayment period of 1 to 5 years, or you can apply for a residential loan with a repayment period of 1 to 15 years.

No documentation is required for a general purpose loan, but you must submit documentation (such as a contract for the purchase of your residence) to support the amount you are requesting for a residential loan.

 

[Purseval]

Are they active duty? Retired? Civlian employees of the government? Did they completely empty it or did they do a loan instead?

I think they took out a loan for a primary residence once years ago. Then they sold that residence when they moved back overseas. They must not have qualified for a second loan, I don't really know the details.

Does anyone know what the IRS is charging now for interest on installment payments? Now that they know their tax software wasn't messed up they have to find out the best way to pay it off, perhaps the government gives a better rate than the banks.

 

[bumbershoot]

We were just looking into that but when the IRS recommends a bank loan or credit card to save money on penalties and interest an installment plan from them doesn't sound too promising.

I'm sure the IRS suggests it, but in reality they aren't heinous to work with while paying them. My MIL has been slowly paying them around 50K b/c of what her now late husband was doing (or wasn't doing...he hadn't filed taxes in the 6 years before his death, but told her he was (online filing after the first time doesn't require actual signatures so there was nothing for her to do with the taxes so she didn't suspect)), and apart from the actual paying of money when she's on a fixed income, the IRS itself is actually quite pleasant to deal with, when you are coming to them setting up a plan and paying on it.

 

[msmayor]

When the amount owed is greater than $25,000, there's no set repayment plan; I believe it has to be negotiated. Taxpayer submits a plan (there are forms) and waits for approval.

What needs to be factored in to the repayment is that the interest rate may be in the neighborhood of 4%, but penalties will continue to be charged and added to the amount still outstanding. The IRS will agree to a plan, but they do not waive the penalties for not paying on time. This can be somewhere in the neighborhood of 0.25-0.5% per MONTH, or up to 6% annually...on a $40,000 tax bill that would be an additional $200 per MONTH at the 0.5% rate.

Interest and penalties would then be in the neighborhood of 10% per year. A home equity loan may be a cheaper option.

 

[bumbershoot]

Interesting. MIL handed it all over to an accountant and he worked out the deal with the IRS (I'm the one that found it all out on the phone when FIL died). She either isn't sharing all of that OR she doesn't know (she hires people based on shared country-of-origin, NOT on if the person is good at their job or not)...aughhhhhhh. Thanks.

 

[msmayor]

Interesting. MIL handed it all over to an accountant and he worked out the deal with the IRS (I'm the one that found it all out on the phone when FIL died). She either isn't sharing all of that OR she doesn't know (she hires people based on shared country-of-origin, NOT on if the person is good at their job or not)...aughhhhhhh. Thanks.

There are a number of variations that can occur; it all depends on the plan submitted and whether the IRS is willing to accept it. Accountants/CPA's who are experienced in dealing with the IRS are truly worth their fees in situations like this, as they know much better how to navigate this minefield.

The IRS just wants their money. And trust me: you cannot just hope it will go away, or think that one late payment is OK. If you set up a plan you MUST stick to it. One slip up and all bets are off.

With the IRS, you are guilty until proven innocent in almost all matters. If you are at all unfamiliar with the process, spending money hiring a professional to help can actually SAVE you money and heartache in the long run.

 

[SOnotLayuh]

Good luck to your sis - this is horrifying!

 

[miknsusn]

Your sister should go directly to a CPA and have her taxes done professionally. Turbo Tax is great for simple tax prep, but with the money she is dealing with this year, she needs an expert.

 

[seashoreCM]

If the total 2009 estimated and withheld tax including the amount earmarked for the 10% withdrawal penalty already paid was more than the previous year's (2008) tax dollars on a quarter by quarter basis, there will be no penalty for not making enough estimated tax for 2009 on a quarter by quarter basis. You would have to finish paying the difference by April 15 (2010).

Seems like renting would have been better compared with increasing taxable income (and tax) and also coming up with a penalty for withdrawing retirement account money to make a down payment with.

Disney hints: http://www.cockam.com/disney.htm

 

[msmayor]

If the total 2009 estimated and withheld tax including the amount earmarked for the 10% withdrawal penalty already paid was more than the previous year's (2008) tax dollars on a quarter by quarter basis, there will be no penalty for not making enough estimated tax for 2009 on a quarter by quarter basis. You would have to finish paying the difference by April 15 (2010).

Seems like renting would have been better compared with increasing taxable income (and tax) and also coming up with a penalty for withdrawing retirement account money to make a down payment with.

Disney hints: http://www.cockam.com/disney.htm

You're correct....there's should be no penalty for underpayment. But there WILL be a penalty assessed on all amounts not paid by April 15 2010. That's the monthly interest charge.

I think the problem here is coming up with that large balance by 4/15. Not many folks can scrape up $40K in 2.5 weeks.