How to Save Tax by Eliminating Estimated Tax Penalties
Imagine this. You were supposed to make four estimated tax payments of $100,000 each during the year, but you didn’t make any of them. Now it’s October, and your tax advisor tells you that both the IRS and the State of California are about to charge you penalties for underpayment. The IRS charges around 7 percent, and California adds its own 8 percent or more. On $400,000 of missed payments, that’s roughly $60,000 in combined penalties—money you lose for no benefit at all.
The good news is, you can use a completely legal strategy to erase those penalties almost instantly. You’ll use your retirement account, the 60-day IRA rollover rule, and some smart timing to satisfy both federal and California estimated tax requirements—all without paying extra income tax or permanent withdrawal penalties.
Example: How to Instantly Stop Federal and California Penalties
Let’s say you owe $400,000 in estimated taxes for the year, and you missed your April, June, and September payments (a total of $300,000). Sending a check now won’t undo those missed due dates—it only prevents more penalties from adding up.
Instead, here’s a better move. You take $400,000 from your IRA and instruct your IRA custodian to send the entire amount to the IRS and California Franchise Tax Board (FTB) through tax withholding. For example, you might direct $320,000 (80 percent) to the IRS and $80,000 (20 percent) to California.
Both the IRS and the FTB treat withheld taxes as if they were paid evenly throughout the year. That means even though you made the payments in October, they’re applied as if you paid quarterly on time. Then, within 60 days, you repay your IRA in full using money from your savings or investment account.
Result: both your federal and California underpayment penalties vanish—and because you returned the IRA funds within 60 days, you don’t owe any tax or early withdrawal penalties on the transaction.
Why This Strategy Works So Well
Withholding from retirement accounts is treated differently than estimated tax payments. Estimated taxes count only when they’re made, but withholding is considered paid evenly throughout the year, no matter when it actually happens.
By combining that rule with the 60-day rollover rule, which allows you to withdraw and replace IRA funds within 60 days tax-free, you create a perfect fix for late or missed estimated payments. The IRS and California both recognize this timing advantage.
Which Retirement Accounts Qualify
You can use this approach with most major retirement plans, including:
Traditional IRA
Roth IRA
SEP IRA
SIMPLE IRA
401(k)
403(b)
457(b)
Keep in mind that IRAs have a one-rollover-per-year rule across all your IRAs. However, that limit does not apply to 401(k), 403(b), or 457(b) plans, which can make planning easier if you have multiple accounts.
If You’re 73 or Older: Use Your RMDs to Your Advantage
If you’re already required to take required minimum distributions (RMDs), you can have taxes withheld directly from your RMDs instead of making separate payments. This approach lets you:
Fulfill your RMD obligation for the year
Catch up on estimated taxes for both federal and California
Avoid late payment penalties entirely
This can be an especially easy and penalty-free way to stay compliant for retirees.
Avoid the “Bonus” Fix
Many S corporation owners try to make up for missed estimated payments by paying themselves a big W-2 bonus and withholding taxes from it. On the surface, that might sound like it works—but it usually costs you more in the long run.
Here’s why:
Payroll taxes on a large bonus can easily exceed $15,000.
Extra wages can reduce your 20 percent Qualified Business Income (QBI) deduction, which means you’ll pay more overall tax.
California payroll taxes also apply, adding another layer of cost that makes this method less efficient.
So while it feels like a quick fix, it’s actually much more expensive than using the IRA rollover approach.
The Bottom Line
If you live in California and you’ve fallen behind on your federal and state estimated tax payments, you don’t have to accept the penalties. By using the 60-day IRA rollover strategy, you can:
Instantly eliminate underpayment penalties for both the IRS and the California Franchise Tax Board
Avoid creating new taxes or withdrawal penalties
Keep your money invested and working for you
For those already taking RMDs, directing federal and state withholding from those distributions can achieve the same result without any extra steps.
In short, this simple timing strategy can save you tens of thousands of dollars in unnecessary penalties—and help you stay in good standing with both the IRS and California while keeping more of your hard-earned money.
