prepaying 10% excise tax

[wsp]

I have a participant who's hardship withdrawal request includes enough to cover his withholding and his 10% penalty. Is anyone aware of any reason that he cannot include that 10% penalty amount with the deposit of the federal withholding for the distribution? He works for a small company so they are flexible if this is allowed.

[kocak]

my understanding is the 20% mandatory withholding that applies to eligible rollover distributions does not apply to hardship distributions. thus, doesn't the participant get to choose if they want withholding or not and what amount, with a default of 10%.

Michele

[Fredman]

I think the question is whether you can "gross up" the hardship amount and include taxes and penalties.

According to the ERISA Outline Book (2001 edition, Chapter 6, Section IV Part C.4c) you can gross up the hardship amount for taxes and penalties. Also see, Treas. Reg. §1.401(k)-1(d)(2)(iv)(B)(1).

[Earl]

Seems to me that the question is can the 10% premature distributoin penalty be paid with the deposit of the x% (10% default) income tax withholding.

I believe the answer is no because by definition any amount paid is paid as income tax witholding. The person would then have 30% withholding and the 10% would still be due with the filing of the 1040 with a 5329. I don't believe that any refund the person might be due could be earmarked/transfered as a credit to the 10%. They would have to pay the 10% and get a refund (or pay more taxes, if that is the case.)

He better just set the 10% aside.

[kocak]

Thanks for the clarification, I didn't realize the 10% penalty was paid separately. I thought it was just lumped in with your total tax due.

mck

[jevd]

Check the instructions for form 5329 and the form. The tax is included on the 1040, so it appears that you could include the extra 10% withholding and use it as a credit against the total tax including amounts due from the 5329.

[MGB]

People need to get their terminology correct. The 10% early withdrawal tax is not a penalty, it is not an excise tax, it is an "additional tax." It operates in the same manner as raising the marginal income tax rate by 10%. This distinction is important because certain things can be waived and others cannot be under normal conditions (a penalty can be waived, a regular tax cannot). And, as was discussed here, the fact that it is a regular tax has implications for the interaction of withholding and taxes due.

Yes, the withholding does get used for satisfaction of the 10% additional tax, whethere the withholding was the standard amount or if it was increased to an individually-designated amount.