Cashing out a 401(k) to pay the IRS creates a new tax liability

A taxpayer who withdraws $20,000 from a 401(k) to pay a $20,000 tax bill may only receive $13,200 in cash. This occurs because the IRS treats early distributions as ordinary income, adding the distribution amount to the regular salary for the year. This addition can increase the taxpayer's tax bracket. The IRS also applies a mandatory 10% early withdrawal penalty for those who touch the money before age 59.5. In a scenario where the taxpayer is in the 24% tax bracket, they owe $4,800 in federal income taxes and a $2,000 penalty. The taxpayer still owes the IRS $6,800.