If you receive a lump-sum payment, you might need to have tax withheld in order to avoid an under-payment penalty. To take care of this chore, you can ask the payer to withhold part of the money for federal taxes. Not all payers will accommodate you, but employers and investment accounts might withhold part of a lump-sum payment at your request.
Payment from Employer
If you receive salary or wages from an employer, you need to fill out Form W-4. This form allows you to set your number of personal allowances, which normally equals the number of people whom you support. However, you can set the number of allowances as you wish. The more allowances you claim, the less tax your employer will withhold from your paycheck. You can also ask for a specific amount of withholding. If you are expecting a lump sum from your employer, you can file a new W-4 with fewer allowances and then re-file after receiving the money. Your employer might be willing to make a special withholding for the lump sum without a new W-4.
Investment Account Payments
Normally, your bank, broker or mutual fund will not withhold money you earn through savings or investments. However, these institutions will perform “backup withholding” under certain conditions, such as not having your correct Social Security number or because the Internal Revenue Service is on your case for under-reporting interest or dividends. You can ask your account provider to make a special withholding for an upcoming lump-sum payment. It might have forms you can fill out to set up a one-time withholding.
The federal government has a special form, W-4V, to allow you to make a voluntary withholding request on certain payments. You normally use W-4V for periodic payments, but it also works on lump sums. You can use W-4V on payments arising from unemployment compensation, Social Security benefits, railroad retirement benefits, loans from the Commodity Credit Corporation and certain disasters. None of these payments require federal withholding, as your request is purely voluntary. The Internal Revenue Service allows only certain set percentages to be withheld through a W-4V.
The IRS frowns on under-withholding and slaps you with a penalty if you break the rules. To avoid this, you can make an estimated tax payment using Form 1040-ES. The IRS provides worksheets and rate tables in Publication 505 to help you figure how much you should withhold. If you can’t have part of the lump-sum payment withheld, you can use the same publication to figure out how much to fork over in an estimated payment. You can pay online, over the phone or via a check or money order. If you owe a penalty for under-withholding, fill out Form 2210 to figure the amount you owe.
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.