Q. If the 10% penalty is $2,000, can your tax be lower than $2,000 if you had enough deductions?? 

A. When you prepare your tax return, the federal income tax is based upon your taxable income, which is your income minus standard or itemized deductions and minus personal exemptions.
After that tax is calculated, you add the 10% penalty ( which is 10% of the “early distributions” themselves, not 10% of the income tax).

If you would otherwise have had a tax due of $ 1,000 ( i.e. tax of $ 5,000 – estimated taxes and witholdings), and there was a $ 2,000 penalty ( 10% of $ 20,000 early distributions), then you would owe $ 3,000. On the other hand, if you were due a refund of $ 3,000 then this $ 2,000 penalty would be offset, and you would get only a $ 1,000 refund.

The answer is a post made by Dlz in response to a question in the discussion forum.