Estimated tax, catchup withholding and penalties

[Gumby]

I'm trying to understand this but am coming up short.

Let me propose a basic scenario with made up numbers:

You receive $24k a year in Social Security.
You draw $2k a month from a tIRA.
You have after-tax investments that will yield $10k in dividends/CGD's for the year.

You know that you will owe $2885 in federal taxes (Single, no dependents) and want to pay those taxes using after-tax dollars.

How would you do so?

You have various options:

1. You could file an IRS Form w4v with the SSA and have them withhold 10% of you monthly Social Security check ($2400) then write a $485 check at tax time.

2. If your custodian allows, you could set up to have tax withheld in the amount of $240 from each of your monthly tIRA draws.

3. You could have no withholding and make 4 quarterly estimated payments of $721 each.

4. Apart from your pre-existing regular monthly withdrawals, you could withdraw $2885 from your tIRA in December and designate it to be completely withheld for taxes. Then, no more than 60 days from that withdrawal, you deposit money from your after tax account into your tIRA and treat it as an indirect rollover.

 

[cathy63]

I'm trying to understand this but am coming up short.

Let me propose a basic scenario with made up numbers:

You receive $24k a year in Social Security.
You draw $2k a month from a tIRA.
You have after-tax investments that will yield $10k in dividends/CGD's for the year.

You know that you will owe $2885 in federal taxes (Single, no dependents) and want to pay those taxes using after-tax dollars.

How would you do so?

Lots of options:
1) Have 12% withheld from your Social Security and end up owing $5 when you file.
2) Make an additional withdrawal from your IRA in December for $3000 and have 100% withheld. (It has to be more than $2885 because you will be increasing your taxable income by the amount you withdraw. You could calculate this amount more accurately, but with $3K you'd end up owing approx $30 when you file the return.)
3) Ask your IRA custodian to withhold $240.42 from each monthly withdrawal.
4) Ask your IRA custodian to withhold more from a fewer number of payments.
5) Make 4 equal estimated payments of $721.25 via check or direct debit.

If I knew my income this accurately, I'd go with option 1 and just have the withholding taken out of the SS payments.

edit: I see Gumby and I were typing at the same time.

 

[ncbill]

For Roth conversions I don't withhold any taxes.

I just go ahead & pay estimated federal & state taxes on those immediately via electronic transfer from taxable.

 

[OldShooter]

I was curious about the argument over whether paying taxes at the end of the year by withholding 100% of an IRA distribution is a legal approach to taxes or a technical violation that taxpayers can get away with (e.g. like slow rolling a stop sign or driving 9 MPH over). Unfortunately, I couldn't find any definitive answer. I did find articles, like this one at Kiplinger, that recommend the approach for paying all taxes. They all say the IRS treats the late taxes as having been withheld over the entire year. That doesn't prove that it is legit but I couldn't find any articles or advice saying it is not legit. Instead of asking for proof that it is OK, I would assume that, in light of the common practice with no rulings to the contrary, it is reasonable to assume that it is legit and apply Judge Hand's reasoning that it is not a sin.

According to The Tax Adviser website (an AICPA publication), section 3405(f) of the IRC states that withholding from pensions, annuities, and other deferred income are to be treated same as wage withholding... meaning it is deemed to be spread evenly. ...

Yes to both. [MOD EDIT]

 

[SJhawkins]

Still "working" so dont have to deal with this, I do keep an eye on the safe harbor rule however.

To be honest all this seems like such a goat show for someone in the "avanced years" to deal with. Maybe a law/rule, for anyone with an income of less than $100, 000 can just settle up in April and its all good. The last thing I want to mess with is dealing with taxes all year in retirement, I hope to have better things to do

 

[RunningBum]

Still "working" so dont have to deal with this, I do keep an eye on the safe harbor rule however.

To be honest all this seems like such a goat show for someone in the "avanced years" to deal with. Maybe a law/rule, for anyone with an income of less than $100, 000 can just settle up in April and its all good. The last thing I want to mess with is dealing with taxes all year in retirement, I hope to have better things to do

There is a provision for this, no penalty if you owe less than $1,000.
https://www.irs.gov/payments/underpayment-of-estimated-tax-by-individuals-penalty under the "Avoid a Penalty" section.

My fed tax usually falls under that, but there's always a chance I would decide to take more income so I just use safe harbor. When I file my taxes, I divide the total tax by 4 and set up 4 equal payments for the next year via EFTPS. Quick and easy, and for this small amount it doesn't seem worthwhile to do with withdraw/withhold/replenish thing and worry about the 12 month rule.

 

[youbet]

To be honest all this seems like such a goat show for someone in the "avanced years" to deal with. Maybe a law/rule, for anyone with an income of less than $100, 000 can just settle up in April and its all good. The last thing I want to mess with is dealing with taxes all year in retirement, I hope to have better things to do

Aw, don't sweat it SJhawkins. As RunningBum says, there isn't much to it. If you use the "safe harbor" benchmark, calculations are a no-brainer. And there are several easy ways (as discussed) to satisfy the IRS regarding the timing of your payments.

 

[audreyh1]

Still "working" so dont have to deal with this, I do keep an eye on the safe harbor rule however.

To be honest all this seems like such a goat show for someone in the "avanced years" to deal with. Maybe a law/rule, for anyone with an income of less than $100, 000 can just settle up in April and its all good. The last thing I want to mess with is dealing with taxes all year in retirement, I hope to have better things to do

Seriously, the safe harbor rules do make this easy. A lot of retired folks follow those because their taxable income doesn’t vary much and the rules are almost no brainers.

My taxable income varies a lot, so I spend more time on it. But this year I used the safe harbor rule to pay for the first 3 estimated quarterly payments, and didn’t think about it at all, once we completed 2021 taxes. I also preschedule estimated tax payments via EFTPS, so convenient.

 

[scrabbler1]

There is a provision for this, no penalty if you owe less than $1,000.
https://www.irs.gov/payments/underpayment-of-estimated-tax-by-individuals-penalty under the "Avoid a Penalty" section.

My fed tax usually falls under that, but there's always a chance I would decide to take more income so I just use safe harbor. When I file my taxes, I divide the total tax by 4 and set up 4 equal payments for the next year via EFTPS. Quick and easy, and for this small amount it doesn't seem worthwhile to do with withdraw/withhold/replenish thing and worry about the 12 month rule.

In some years, when I completed the Estimated Tax worksheet at the start of the year, my projected income tax bill was around $800. This meant I hit a safe harbor (under $1,000 tax) and stopped at Line 14b of that form. No Form 2210. No estimated tax due. No taxes withheld, either.

But late December, I'd get an unexpected cap gain distribution which boosted my tax bill to $1,100. If I then filed Form 2210, it would show I owed some taxes in the first 3 quarters despite the highly skewed nature of my income. There is no way I'd file Form 2210 and expose this because the worksheet I filled out a year earlier indicated I owed nothing at the time in any quarter.

I'd simply fly under the IRS's radar by sending them about half of what I owed in estimated taxes, around $600, by January 15th. Then I'd pay the rest in April. I did this several years and never got questioned. I suppose with such small amounts involved, the IRS doesn't really care as long as the return is otherwise correct and I am paying what I owe.

 

[NW-Bound]

... I suppose with such small amounts involved, the IRS doesn't really care as long as the return is otherwise correct and I am paying what I owe.

I would not be surprised that the IRS computer is programmed to ignore a small infraction if pursuing it costs them more money than they can extract from you.

 

[cathy63]

... Then I'd pay the rest in April. I did this several years and never got questioned. I suppose with such small amounts involved, the IRS doesn't really care as long as the return is otherwise correct and I am paying what I owe.

We have a Tax-Aide client who routinely owes $1000 to $1500 in taxes. Every year we explain that there may be a penalty and the IRS may send him a bill and if he would setup some withholding on his pension or let us give him some vouchers for estimated taxes he could avoid this. Every year he refuses and says they've never sent him a letter and he doesn't want to do anything different. Well, last year he came in all irate because the IRS wanted him to pay the penalties for the three prior years.

So based on my experience, I'm going to say they'll eventually catch up with you. You might get away with it for quite a while before that happens though.

 

[gauss]

In some years, when I completed the Estimated Tax worksheet at the start of the year, my projected income tax bill was around $800. This meant I hit a safe harbor (under $1,000 tax) and stopped at Line 14b of that form. No Form 2210. No estimated tax due. No taxes withheld, either.

But late December, I'd get an unexpected cap gain distribution which boosted my tax bill to $1,100. If I then filed Form 2210, it would show I owed some taxes in the first 3 quarters despite the highly skewed nature of my income. There is no way I'd file Form 2210 and expose this because the worksheet I filled out a year earlier indicated I owed nothing at the time in any quarter.

I'd simply fly under the IRS's radar by sending them about half of what I owed in estimated taxes, around $600, by January 15th. Then I'd pay the rest in April. I did this several years and never got questioned. I suppose with such small amounts involved, the IRS doesn't really care as long as the return is otherwise correct and I am paying what I owe.

edit: It it is possible that this may not fully relieve you of a penalty for the first 3 quarters if you had income in these quarters and no withholding. I would have to run the example through form 2210 schedule AI to be certain. Perhaps you already explored this.

--
I think there is a more complicated version of the 2210 that handles the situation where your income is not level throughout the year.

You have until the end of the quarter when the income is "earned" to pay the withholding on it. That is to say a large December cap gain distribution should not cause an under withholding penalty for the first three quarters -- if you full out the full version of the form. I believe the full version is Schedule AI of form 2210.

Filling out Schedule AI is a pain, however. It basically forces you to do what amounts to four income tax returns -- one for each quarter.

-gauss

 

[scrabbler1]

edit: It it is possible that this may not fully relieve you of a penalty for the first 3 quarters if you had income in these quarters and no withholding. I would have to run the example through form 2210 schedule AI to be certain. Perhaps you already explored this.

--
I think there is a more complicated version of the 2210 that handles the situation where your income is not level throughout the year.

You have until the end of the quarter when the income is "earned" to pay the withholding on it. That is to say a large December cap gain distribution should not cause an under withholding penalty for the first three quarters -- if you full out the full version of the form. I believe the full version is Schedule AI of form 2210.

Filling out Schedule AI is a pain, however. It basically forces you to do what amounts to four income tax returns -- one for each quarter.

-gauss

I was referring to Schedule AI of Form 2210. And a large, December cap gain distribution did show some estimated (but unpaid) taxes due in prior quarters even though I was in a safe harbor for the first 3 quarters (because my total tax bill would have been less than $1,000 had there not been the big CGD in December).

Schedule AI was a PITA, even though I had built a spreadsheet to mimic its calculations.

 

[scrabbler1]

We have a Tax-Aide client who routinely owes $1000 to $1500 in taxes. Every year we explain that there may be a penalty and the IRS may send him a bill and if he would setup some withholding on his pension or let us give him some vouchers for estimated taxes he could avoid this. Every year he refuses and says they've never sent him a letter and he doesn't want to do anything different. Well, last year he came in all irate because the IRS wanted him to pay the penalties for the three prior years.

So based on my experience, I'm going to say they'll eventually catch up with you. You might get away with it for quite a while before that happens though.

Your Tax-Aide client seems to have regular, predictable income which would assure him of having more than $1,000 in taxes due; if he completed the worksheet for the estimated tax form (1040-ES) at the start of the year, he would fail to meet any of its safe-harbor provisions. With me, I had met one of the safe-harbor provisions (<$1,000), so I paid zero in estimated taxes. Only when I got the unforeseen, big CGD in December was I evicted from any of the safe-harbor provisions. I can't go back in time to April, June, and September and make estimated tax payments after the worksheet showed me only in December that I was not longer in the safe harbor.

It would be pretty easy to prove this to the IRS. The date of the large CGD and how much additional income tax it caused would be enough. I'm not worried.

 

[rkser]

Following this informative thread

 

[MarieIG]

Ok - done.

I did it online, and then called a Vanguard rep to confirm that the $ would be withheld for NYS.

He said Vanguard has direct communication with the IRS, so those funds and processed more quickly. He also laughed at me and said, I don't usually hear someone say "I want to pay my taxes."

Part II of the 60 day roll over was completed today. I went down to the local Fidelity, deposited the full amount of the "withdrawal", had my deposit coded as a 60 day rollover, and got a receipt indicating a 60 day rollover.

 

[rayvt]

I have to think about the strategy because it does sound odd to pay your taxes while increasing income at the same time.

You do it late in December and do a 60-day rollover in January from your RMD. Then does not count as income in the former year, but is income in the later year -- which you have to take anyway as RMD.

 

[rayvt]

So, as long as that withholding plus your monthly pension withholding is sufficient to get you over the safe harbor amount or within $1000 of the taxes due, you should be golden.

And even if you don't quite get to the safe harbor it's not that big of a deal. The penalty is small, and is calculated only on the amount that you fall short of the safe harbor.

 

[rayvt]

So, not paying taxes throughout the year, then paying it all at the end of the year would not be kosher.

However, there's no mechanism to track this, so people get away with it.

No, the IRS does have the mechanism to track this (quarterly at least).

But the IRS specifically says that _all_ withholdings are deemed to be paid equally throughout the year, no matter when the withholding takes place. Thing is, it's a bit hard to figure this out, because it is spread out over 2 or 3 IRS publications, so lots of people are not aware of it.

 

[rayvt]

Now, I wonder if you need to "rollover" to a 2nd IRA, or just putting it back to the original IRA is OK.

You can put it back into any IRA account that is yours. IRS & courts say that you have only ONE IRA, no matter how many different IRA accounts you have. The "A" in IRA stands for "arrangement" not "account".

When you withdraw from an IRA, don't you have to specify what type of withdrawal that is? If so, you cannot do a Mulligan, change your mind and say it's now a rollover. Right?

No. The custodian only asks if it is a qualified withdrawal or not, so they know if they are required to deduct some of it as penalty. They neither ask nor care what you are going to do with the money.
It's just that you can only do one rollover every 365 days. And you have to get the money back into an IRA within 60 days.

 

[audreyh1]

I was referring to Schedule AI of Form 2210. And a large, December cap gain distribution did show some estimated (but unpaid) taxes due in prior quarters even though I was in a safe harbor for the first 3 quarters (because my total tax bill would have been less than $1,000 had there not been the big CGD in December).

Schedule AI was a PITA, even though I had built a spreadsheet to mimic its calculations.

I’ve done annualized income (AI) method for estimated taxes many times because my annual income is very unpredictable and the bulk of it comes in December. Generally use it if an expected low income year follows a high income year and I don’t want to overpay estimated taxes.

But the basic thing is - as long as you’ve paid the estimated tax according to the AI method after the end of each quarter, there will be no penalty. You do usually have to file the form 2210 to show where you income occurred by tax quarter.

This year I’m doing my favorite shortcut method of paying the first three installments according to prior year taxes and then seeing if I owe anything for Q4. So far it looks like I’ve already overpaid for the year. So I’ll be skipping the 4th quarter estimated tax payment and applying any refund against next year’s taxes. TurboTax doesn’t file a 2210 form in this case because you already met the minimum criteria each of the first 3 quarters.

 

[NW-Bound]

No, the IRS does have the mechanism to track this (quarterly at least).

But the IRS specifically says that _all_ withholdings are deemed to be paid equally throughout the year, no matter when the withholding takes place. Thing is, it's a bit hard to figure this out, because it is spread out over 2 or 3 IRS publications, so lots of people are not aware of it.

Thanks.

I do lumped-in tax payments at the end of the year, but thought it was permissible because the IRS got only a year-end summary from the trustee.

It's surprising that IRA owners get a lenient treatment, even though their withdrawals as you say can be easily tracked to make sure taxes are withheld on a timely basis.

On the other hand, other income earners are faced with more paperwork for quarterly payments.

 

[NW-Bound]

No. The custodian only asks if it is a qualified withdrawal or not, so they know if they are required to deduct some of it as penalty. They neither ask nor care what you are going to do with the money.
It's just that you can only do one rollover every 365 days. And you have to get the money back into an IRA within 60 days.

I have done countless withdrawals for spending, but never for indirect rollover. So I did not know if I had to have the right distribution code in box 7 of the form 1099-R.

For a normal distribution (for spending), the code is 7 for "Normal Distribution"

And if I needed a different code for an indirect rollover, how would the trustee issuing the 1099 know if I was going to really redeposit it or not?

Hence, my confusion.

 

[daver]

I just did a t-IRA distribution with withholding for taxes this week and will perform a 60 day rollover back to the same IRA. I also want to move my prior workplace HSA to a Fidelity HSA. To expedite the transfer I'm going to have the funds deposited to my checking then over to Fidelity HSA using the 60 day rollover rule. The direct rollover between HSA custodians will require paper forms and check sent snail mail etc and can take weeks.

I read that the once per 12 month 60 day rollover rule is separate for HSAs and IRAs. I hope I understand this correctly?

 

[mickeyd]

Like most of us here, I deduct (withhold) between 20% and 30% from RMD and other income producers. 20% is probably short of the mark and 30% is probably over and refundable when IRS reviews the entire tax submission.