When making this distribution, can taxes be withheld for Federal and State payments in excess of the $10,000 penalty free amount? That is, can I receive the full $10,000, but withhold $2,500 for Federal income taxes (as an example) and not be penalized on the $2,500? After all, I'm not distributing those funds, but simply covering the additional ordinary income tax liability I'll incur from the $10,000 distribution. Thanks!
That depends on your plan. This question can only be answered by the plan administrator. There is no law that requires withholding. But it may or may not be a requirement of your plan. So ask your plan administrator.