Estimating taxes for the first time

[Badger]

This past year I didn't know how to plan for estimating my taxes and paid a lump sum to the IRS in October that turned out to be way to much. It was nice getting some of my money back but I would rather not repeat the same mistake again. I finally downloaded my free tax program from Vanguard and started playing "what if" for 2014.

I would like to convert $20k tIRA money to a Roth and stay within a 15% tax bracket if going to a higher tax bracket increases the Capital Gains and Dividends tax. The TT program says this will make the Adjusted Gross Income a little over $100k but my Taxable Income a little over $78k. If AGI is used then I go to a higher tax but if Taxable Income is used then I should be good. Which number is used?

In a few years when we will reach 70.5 I will have to cash in some IRA money that will put us into a 25% bracket anyway but I was hoping to save a couple of dollars in the meantime.

Cheers!

[kaneohe]

Taxes are based on taxable income . I assume you're filing MFJ?
I think the top of the 15% bracket is 73.8K (not 78K) so you should plan on
staying lower than that.

[pb4uski]

What I do is a faux 2014 return using the 2013 TT software pluging in my best estimates of income from taxable accounts, HSA contributions and deductions. Then I solve for the amount of tIRA>Roth conversion that brings me to the top of the 15% bracket. I periodically update it and then do it in the 2014 TT software once it comes out and update it one last time in late December after I have received my late year dividends and have done my end of year rebalancing. The I do the Roth conversion.

It sounds like a lot but each step is probably 15-30 minutes at the most.

I have no tax liability until the last quarter so I don't pay my estimated payments until late December as well. As a result, I do have to do an analysis of my return by quarter to avoid any underpayment penalities, which is a bit of a PITA (probably an hour exercise when I do my return) but I could easily avoid this by just making quarterly estimated payments (which I'm thinking of doing).

[braumeister]

This is a simple tool, but I've always found it close enough for me.
1040 Tax Calculator

[Jager]

Like others, I recommend obtaining software that allows you to run various what-if scenarios. I like the Taxcaster myself. Since it's on my iPad, which is pretty much always with me, I can very quickly check the tax implication of any question that pops to mind.

Very quick. Very simple to use.

[Animorph]

If your taxes will be higher than last year, pay enough estimated taxes to reach the "safe harbor" of 100% or 110% of last year's taxes. That's the simplest approach.

If you will be Roth converting to a tax bracket target, you may have a good idea of what your taxes will be because of that. The mix of capital gains and income can change for me though, so that's not a perfect estimate. It is for my state taxes though, which treat capital gains the same as income.

For Roth conversions you can recharacterize all or a portion of a conversion at tax time. What I do is convert more than I expect to need, in multiple (otherwise empty) Roth accounts, placing shares of only one fund in each account, and never more than about 1/8 of the total in any one account. At the end of the year I do the same thing with cash, starting with about 1/2 of my largest conversion account value and then halving that number several times into maybe three more accounts. During the tax year I might also convert additional shares into a new Roth account if the price drops 10% or more.

Then when I'm doing taxes in March or April the following year I calculate how much I can convert and still stay within the target tax bracket. I retain the Roth conversions that hold the most appreciated shares, and use the cash Roth conversions to fill in as close to the tax bracket as I can. I might also buy shares of any fund that has a particularly low price at that time with the Roth cash. The Roth conversions that I don't want are then recharacterized, and treated by the IRS as if they were never moved out of an IRA. The recharacterization process can be a little bit of a pain, and I'd start it in March just to make sure it is complete before you send in your taxes. But this is one of the very few times you get to "look into the future" a few months and make a late call on what conversion worked best for you.

[audreyh1]

I did the "safe harbor" method last year, and I only slightly overpaid and applied the refund to this year's estimated taxes.

But I expect the safe harbor this year to be way too high. It's that 10% extra over the prior year's taxes that is really too much and will probably result in us way over paying this year.

So I may resort to the annualized method again. I'll probably pay the first two quarters following the safe harbor guideline and evaluation after August. We do get most of our income in December which can make it tricky.

Another option is for me to pay three quarters followed the safe harbor guideline and then in January aim for the 90% of taxes owed estimate. That's a more likely strategy.

When I was contemplating the Turbotax deal using refund to buy Amazon gift cards with 10% bonus, I realized that I shouldn't be getting any refund in the first place!!!!! I need to be paying the final 10% in April, not getting a refund!

I keep track of the income quarterly anyway, because it's not that hard for me and I have the spreadsheets already.

[Badger]

I'll have to start all over. My reply just got lost when sending.

I was thinking of just using the maximum tax in the 15% bracket for taxable income for 2014. That would take care of estimating taxes. Then use Turbo Tax with all my income, deductions, etc. but without the Roth conversion. The difference between the taxable income and the maximum of $73,800 would be what I could convert to a Roth.

I will probably give myself a little wiggle room of $1k on the Roth just to be safe. That would prevent any penalty and overpayment would be small.

If this sounds right then it should be easier than I thought it would be. If this is not right then what do I need to change?

Thanks for all your help.

Cheers!

[gerntz]

Last year I paid taxes with tIRA withdrawal withholding in 4Q vs. doing estimated payments. Most of our income was created in 4Q between the withdrawal/Roth Conversion, mutual funds distributions, and cap gains from sales. I knew about how much to withdrawal by then.

[pb4uski]

Good idea on basing your estimated payments on $73,800 of TI. One nuance you may want to adjust for though is qualified dividends and LTCG. IOW, if your TI is $73,800 your qualified dividends and LTCGs are taxed at 0% and the remainder at ordinary rates so the total will be less than the maximum tax for the 15% bracket (and perhaps quite a bit less depending on the proportion of qualified dividends and LTCG to the total).

What I think I would do is make your best estimates of qualified dividends and LTCG, fill the rest of the 15% bracket with ordinary income (including your Roth conversions) and then see what the resulting tax is.

For example, using Taxcaster and 2013 rates, if you had $92k of ordinary income your TI would be $72,000 for MFJ with standard deduction and your tax would be $9,911. However if instead your $92k of income was $72k of ordinary income and $20k of qualified dividends or LTCG, your TI would still be $72k but your tax would be $6,911. So if you use your approach you would overpay by $3k.

Quote:

Originally Posted by Badger I'll have to start all over. My reply just got lost when sending. I was thinking of just using the maximum tax in the 15% bracket for taxable income for 2014. That would take care of estimating taxes. Then use Turbo Tax with all my income, deductions, etc. but without the Roth conversion. The difference between the taxable income and the maximum of $73,800 would be what I could convert to a Roth. I will probably give myself a little wiggle room of $1k on the Roth just to be safe. That would prevent any penalty and overpayment would be small. If this sounds right then it should be easier than I thought it would be. If this is not right then what do I need to change? Thanks for all your help. Cheers!

[scrabbler1]

Quote:

Originally Posted by gerntz Last year I paid taxes with tIRA withdrawal withholding in 4Q vs. doing estimated payments. Most of our income was created in 4Q between the withdrawal/Roth Conversion, mutual funds distributions, and cap gains from sales. I knew about how much to withdrawal by then.

I did this for my friend who has RMDs from an inherited IRA. He works full-time so he doesn't need the $3,000 RMD we take late in the year for his everyday expenses. We use 99% of it to pay federal and state income taxes to lessen his tax bills (he has a large, inherited brokerage account) in April and keep him in "safe harbors" for state and federal, emphasizing the state side so (a) he can deduct those state income taxes on that year's federal income tax return, and (b) only have to make a subsequent estimated tax payment for the Feds.

[Animorph]

Quote:

Originally Posted by Badger I'll have to start all over. My reply just got lost when sending. I was thinking of just using the maximum tax in the 15% bracket for taxable income for 2014. That would take care of estimating taxes. Then use Turbo Tax with all my income, deductions, etc. but without the Roth conversion. The difference between the taxable income and the maximum of $73,800 would be what I could convert to a Roth. I will probably give myself a little wiggle room of $1k on the Roth just to be safe. That would prevent any penalty and overpayment would be small. If this sounds right then it should be easier than I thought it would be. If this is not right then what do I need to change? Thanks for all your help. Cheers!

As long as you are in the 100%/110% safe harbor or have paid 90% of the tax due there should be no penalty. I went ahead and converted just a little more than my target. It cost me $7 in AMT tax (the start of AMT was my limit this year). Crappy marginal rate I'm sure, but $7 won't kill my retirement plans.