Withholding more than 20% from a distribution?

[AlbanyConsultant]

I've got a doctor who worked with his accountant to withdraw money from his PS plan several times last year. In each instance, instead of withholding 20% and remitting it through normal channels (and never mind filling out distribution forms!), he figured what the effect of the distribution would be on his total 2004 taxes and then sent in estimated taxes accordingly.

[For example, if he's in a 30% tax bracket, and he took $40,000, he would have sent in $12,000. If the next distribution of $60,000 put him at at 40% tax bracket, he would have sent in $24,000.]

Yeah, I had to pick my jaw up off the floor, too.

And of course, I first learn of this on 2/7, and am asked to prepare the 1099-R, etc.

So I will reflect the gross distributions in Box 1 of the 1099-R. And all taxable, since they were all cash payments. For withholding, I suppose that it would be the total of these amounts that were calculated, even though it will be more than 20%. And since he's 58 and termed, he meets the Code 2 exceptions for Box 7, so at least there's no additional 10% penalty.

The questions I have are:

1. Is there a problem in general with withholding MORE than 20%? I can't imagine that the IRS would be upset with getting more money sooner.

2. How in the world is the money already sent to the IRS (presumably under the doctor's SSN and not the employer's EIN) going to get matched up? There's going to be an issue with the 945 showing a payment under the employer's EIN, but it not being there, and I expect it will only get resolved when the IRS sends a notice and really looks into it.

3. Assuming that this all did really happen on the accountant's advice, can I somehow justify grievous bodily harm to said accountant? Mental anguish or something?

Thanks for all your replies.

[Blinky the 3-eyed Fish]

For withholding, I suppose that it would be the total of these amounts that were calculated, even though it will be more than 20%.

No, the 1099 & 945 are reporting withholding from the plan, not the individual. There was no withholding from the plan, so put a $0. That answers your questions as to how to match up the withholdings too.

And since he's 58 and termed, he meets the Code 2 exceptions for Box 7, so at least there's no additional 10% penalty.

Remember, he needs to terminate after age 55. Just because he's 58 and terminated does not mean he necessarily meets the exception.

[Appleby]

1. Is there a problem in general with withholding MORE than 20%? I can't imagine that the IRS would be upset with getting more money sooner.

No. Up to 100% withholding is allowed

[Guest Harry O]

Employees who understand the relationship between the estimated tax rules and the withholding rules will attempt to pay little taxes during the year and then request 100% withholding on their December paychecks. This usually isn't the employer's problem (or plan administrator's in this case) but may subject the employee to penalties if his W-4 was inaccurate for the first 11 months. The employer has potential exposure if it should have known the W-4 was inaccurate or didn't forward a W-4 with 10 or more exemptions to the IRS.

[mbozek]

The max penalty for underpayment of tax withholding during the year is 500 which is rarely enforced as long as an employee withholds 100% of the tax liability for the year by 12/31. Employees increase withholding at the end of the year as a way to avoid penalties for underpayment of estimated taxes during the year (e.g. cap gains) by increasing w/holding due by 12/31 to cover 100% of taxes due. The IRS does not review w-4 forms unless the taxpayer claims an outrageous amount of exemptions (e.g. 99) because of a lack of staff.

[AlbanyConsultant]

No, the 1099 & 945 are reporting withholding from the plan, not the individual. There was no withholding from the plan, so put a $0.

Blinky, I realized this on the way home after posting, so, yeah, that's the way I'm going to go. Which means that there is no 945 filing, because there is no withholding to report.

I've never seen a plan get in trouble for not withholding - has anyone else? Not that I'm going to advise my clients to stop doing it!