Roth conversion, Form 2210, and penalty

[always_learning]

Assume a Roth conversion of $150k in Q1 and other income through the year of $50k, so total income for the year is $200k.

That large Roth conversion in Q1 will require an Est tax payment (based on the formula in Form 2210) that will be more than the total tax burden by about $7,000, depending on deductions/qualified DIV.

I know that a large refund would be in order, but due to the penalty part of the worksheet, if I KNOW I won't exceed a certain amount of taxes through the year, if I pay less than the amount the formula tells me to, even if I still end up with tax overpayment at filing time, I will still owe a penalty?

Do I understand this correctly?

 

[SevenUp]

Assume a Roth conversion of $150k in Q1 and other income through the year of $50k, so total income for the year is $200k.

That large Roth conversion in Q1 will require an Est tax payment (based on the formula in Form 2210) that will be more than the total tax burden by about $7,000, depending on deductions/qualified DIV.

Why?

In the worst case (all ordinary income, single filer under 65, 2022 tax liability much greater than 2023), you would owe $38,400. Four timely estimated payments of $8640 and a payment of $3840 when you file, and you should be all set. What do you see differently?

 

[always_learning]

In my hypothetical above, Form 2210 wants me (well, us, MFJ) to pay roughly $49,000 for period a (I used Q 1 above, but it's really period a on the form) for that $150k conversion, and probably more through the other periods as more income rolls in, but I haven't gone that far yet to see.

Whereas if I compute the year's total income of $200k using the regular tax table, it's $45,996.

As I understand it, the form assumes the yearly income is 4 x that 200k, so wants me to pay assuming I'll be in the 35% bracket, whereas I will be staying in the 24%.

I am obviously not getting something and it's driving me nuts.

 

[audreyh1]

Assume a Roth conversion of $150k in Q1 and other income through the year of $50k, so total income for the year is $200k.

That large Roth conversion in Q1 will require an Est tax payment (based on the formula in Form 2210) that will be more than the total tax burden by about $7,000, depending on deductions/qualified DIV.

I know that a large refund would be in order, but due to the penalty part of the worksheet, if I KNOW I won't exceed a certain amount of taxes through the year, if I pay less than the amount the formula tells me to, even if I still end up with tax overpayment at filing time, I will still owe a penalty?

Do I understand this correctly?

No.

You do not owe more than 1/4 of the previous year’s taxes paid (or 1/4 of 1.1 x previous year’s taxes paid for higher AGI) in any given tax quarter for the current year.

 

[audreyh1]

In my hypothetical above, Form 2210 wants me (well, us, MFJ) to pay roughly $49,000 for period a (I used Q 1 above, but it's really period a on the form) for that $150k conversion, and probably more through the other periods as more income rolls in, but I haven't gone that far yet to see.

Whereas if I compute the year's total income of $200k using the regular tax table, it's $45,996.

As I understand it, the form assumes the yearly income is 4 x that 200k, so wants me to pay assuming I'll be in the 35% bracket, whereas I will be staying in the 24%.

Last year, I apparently did things wrong by looking ahead to what I knew I would owe and divided that by 4 and ended up paying a whopping $1 penalty for an underpayment at some point, yet received over $1,000 back because I purposely overpaid a little.

I am obviously not getting something and it's driving me nuts.

But you only have to pay 22.5% of that, and most importantly you get to pay that or 1/4 of the prior years taxes owed whichever is less. (Note for higher AGI you have to multiply prior year taxes by 1.1).

 

[SecondCor521]

Yes, it is possible to receive a federal income tax refund and still (technically) owe an underpayment penalty if the income is received faster than the estimated taxes (or withholding) are paid. (ETA: And this also assumes that you don't fall into any of the safe harbors as alluded to in the previous several posts.)

The reason is that the federal government expects you to pay estimated taxes based on the assumption that your eventual income will be equal to your YTD income annualized.

What you may be missing is that they also allow and expect you to rerun the YTD calculations every estimated payment period, so if your income is lower in Q2 and you already paid, in retrospect, too much in Q1, then your Q2 estimated payment can be appropriately lower to reflect the lower annualized income estimate and the fact that you've paid ahead somewhat with the Q1 payment. It says this somewhere in the 1041-ES instructions.

(Many people will say that the four estimated tax payments need to be the same. While it is convenient to do it this way, it's not required.)

Note, though, that if you file a full year tax return and are due a refund and you neither calculate nor pay an underpayment penalty, the IRS seems to not enforce the technicality in my first paragraph above. If you paid an underpayment penalty, I suspect that you probably let TT calculate the penalty for you. There should be a way to tell TT not to calculate it for you; they'll warn you that the IRS may calculate a penalty and send you a bill. While true that the IRS could, generally they do not.

 

[d.davis]

2022 is the last year I'm messing with quarterly estimated taxes. I learned elsewhere on this site that a tIRA withdrawal in early december with 99% withheld for taxes is viewed as paid throughout the year. Already calculated in the amount of 100% of last year's tax bill per my spreadsheet.

That IRS form used to determine if you owe a penalty (I never have owed a penalty) is ridiculous and consumes over 60% of my total time doing taxes.
Problem solved.

Sent from my moto g power using Early Retirement Forum mobile app

 

[SevenUp]

In my hypothetical above, Form 2210 wants me (well, us, MFJ) to pay roughly $49,000 for period a (I used Q 1 above, but it's really period a on the form) for that $150k conversion, and probably more through the other periods as more income rolls in, but I haven't gone that far yet to see.

Are you looking at Schedule AI? If so, don't! Use of that part of Form 2210 is optional, and you should use it only if it leads to a better outcome. The better outcome is usually associated with large income at the end, not beginning, of the year.

Whereas if I compute the year's total income of $200k using the regular tax table, it's $45,996.

Even with both under age 65 and all ordinary income, the 2023 federal tax on $200K AGI is $28,521 (if the case study spreadsheet is correct.)

As I understand it, the form assumes the yearly income is 4 x that 200k, so wants me to pay assuming I'll be in the 35% bracket, whereas I will be staying in the 24%.

Where are you reading that in Form 2210?

 

[always_learning]

No.

You do not owe more than 1/4 of the previous year’s taxes paid (or 1/4 of 1.1 x previous year’s taxes paid for higher AGI) in any given tax quarter for the current year.

Hmm. I did not make 4 equal payments. Would this be why I'm getting the numbers I am?

But you only have to pay 22.5% of that, and most importantly you get to pay that or 1/4 of the prior years taxes owed whichever is less. (Note for higher AGI you have to multiply prior year taxes by 1.1).

Does this only work out if income is stable from year to year?

Yes, it is possible to receive a federal income tax refund and still (technically) owe an underpayment penalty if the income is received faster than the estimated taxes (or withholding) are paid. (ETA: And this also assumes that you don't fall into any of the safe harbors as alluded to in the previous several posts.)

The reason is that the federal government expects you to pay estimated taxes based on the assumption that your eventual income will be equal to your YTD income annualized.

What you may be missing is that they also allow and expect you to rerun the YTD calculations every estimated payment period, so if your income is lower in Q2 and you already paid, in retrospect, too much in Q1, then your Q2 estimated payment can be appropriately lower to reflect the lower annualized income estimate and the fact that you've paid ahead somewhat with the Q1 payment. It says this somewhere in the 1041-ES instructions.

(Many people will say that the four estimated tax payments need to be the same. While it is convenient to do it this way, it's not required.)

Note, though, that if you file a full year tax return and are due a refund and you neither calculate nor pay an underpayment penalty, the IRS seems to not enforce the technicality in my first paragraph above. If you paid an underpayment penalty, I suspect that you probably let TT calculate the penalty for you. There should be a way to tell TT not to calculate it for you; they'll warn you that the IRS may calculate a penalty and send you a bill. While true that the IRS could, generally they do not.

I understand how the income and x value decreases with each subsequent period, but I'm annoyed that they are wanting me to essentially overpay if I have a high-earning period a and then not much of anything after that and was hoping there was a work-around for that.

I did let TT compute any penalty for me. Are you saying if I checked the box saying not to compute it that the IRS might not bother with it once someone looked at the numbers?

 

[always_learning]

2022 is the last year I'm messing with quarterly estimated taxes. I learned elsewhere on this site that a tIRA withdrawal in early december with 99% withheld for taxes is viewed as paid throughout the year. Already calculated in the amount of 100% of last year's tax bill per my spreadsheet.

That IRS form used to determine if you owe a penalty (I never have owed a penalty) is ridiculous and consumes over 60% of my total time doing taxes.
Problem solved.

Sent from my moto g power using Early Retirement Forum mobile app

If we were making tIRA withdrawals, we'd definitely do it this way.

 

[pb4uski]

Is the nature of your $50k of income something that you can have withholding done from, like earnings or a pension? I presume not.

Your best bet is to make a big estimated payment and then plan to file 2210, including Schedule AI.

But the payment shouldn't be more than your total tax for the year, but it might we'll be close to all of it. Fill out AI to find out.

Or easy out might be to just pay what you think you'll owe for the year in 1Q.

 

[always_learning]

Are you looking at Schedule AI? If so, don't! Use of that part of Form 2210 is optional, and you should use it only if it leads to a better outcome. The better outcome is usually associated with large income at the end, not beginning, of the year.

Even with both under age 65 and all ordinary income, the 2023 federal tax on $200K AGI is $28,521 (if the case study spreadsheet is correct.)

Where are you reading that in Form 2210?

Huh. TT made it sound like it would be in my favor to use the Schedule AI. I'll rerun it tomorrow without it and see what happens. I thought it *would* be in my favor because I figured the taxes based on what I knew the end result to be + a $1,000 buffer.

I hadn't seen the case study spreadsheet before. I was just using the tax brackets and configuring the amounts from there as I always have done. Before we started doing Roth conversions two years ago, I was only ever off by whatever the qualified DIVs were, so I'm usually pretty spot on with our taxes. I still do them on paper and use TT as a second look but form 2210 is just nuts.

Thanks for the info... I've got some homework to do tomorrow.

Oh, the 35% was the hypothetical income of 150k x 4 in column on the Sched AI = $600k = 35% tax bracket then they make you compute the taxes on that amount which forces an overpay (in my hypothetical situation).

I'm probably doing a horrible job explaining things. Thanks for sticking with me and trying to suss out my problem.

 

[always_learning]

Is the nature of your $50k of income something that you can have withholding done from, like earnings or a pension? I presume not.

Your best bet is to make a big estimated payment and then plan to file 2210, including Schedule AI.

Unfortunately, no.

Well, that's not what I wanted to hear but it sounds like I do understand the form, so yay I guess.

Bummer. It just feels like a penalty to have to pay what I know will end up being a large overage up front and not be able to adjust for income that comes in heavy at the start of the year.

 

[cathy63]

Hmm. I did not make 4 equal payments. Would this be why I'm getting the numbers I am?

Yes, unequal estimated payments lead to penalties. If you know what you'll owe for the year, divide that by 4. Make 4 equal payments. Don't fill out form 2210 or its Schedule AI. The IRS has no way to know whether you did your Roth IRA conversion in January or December unless you tell them, so don't set up a situation where you have to tell them.

Of course, if you win the lottery in December and make a larger Q4 estimated payment, then you'll want to use 2210 and you will have to tell them about the Roth conversion in Q1, which might mean a penalty for having underpaid early in the year. Hopefully the lottery winnings will be large enough to take the sting out of it.

 

[audreyh1]

No.

You do not owe more than 1/4 of the previous year’s taxes paid (or 1/4 of 1.1 x previous year’s taxes paid for higher AGI) in any given tax quarter for the current year.

But you only have to pay 22.5% of that, and most importantly you get to pay that or 1/4 of the prior years taxes owed whichever is less. (Note for higher AGI you have to multiply prior year taxes by 1.1).

Hmm. I did not make 4 equal payments. Would this be why I'm getting the numbers I am?


Does this only work out if income is stable from year to year?

First I am assuming you are trying to figure out 2023 estimated tax payments and how to avoid penalty, and you have an idea of your 2022 taxes.

The safe harbor rule of paying prior years taxes (or taxes*1.1) in 4 equal installments means that you don’t have to pay more than that installment (1/4) each estimated tax quarter, even if your annualized income figured taxes are higher.

The 22.5% was referring to just the Q1 estimated taxes that must be paid using the annualized income method. It has to be recalculated for each tax quarter with different percentages. I suppose you are trying to figure this from Form 2210, but what you really need to do is learn the annualized income method of figuring estimated taxes. Form 2210 is an after the fact check on that method when filing.

But you don’t even have to do that: If you think 2023 taxes are going to be higher than 2022, just use the simple safe harbor rule of prior years taxes (or *1.1) in 4 equal installments and don’t worry about it. Guaranteed no penalty and avoid a big pre-pay and refund.

 

[audreyh1]

Yes, unequal estimated payments lead to penalties. If you know what you'll owe for the year, divide that by 4. Make 4 equal payments. Don't fill out form 2210 or its Schedule AI. The IRS has no way to know whether you did your Roth IRA conversion in January or December unless you tell them, so don't set up a situation where you have to tell them.

Of course, if you win the lottery in December and make a larger Q4 estimated payment, then you'll want to use 2210 and you will have to tell them about the Roth conversion in Q1, which might mean a penalty for having underpaid early in the year. Hopefully the lottery winnings will be large enough to take the sting out of it.

In my experience as long as your Q1 (and subsequent) estimated tax payments meet the prior year taxes/4 (or (taxes*1.1)/4) it doesn’t matter if you win the lottery in Q4. You don’t have to pay any more quarterly estimated tax even if you still owe a huge amount when you file your taxes the following year. No penalty - the very definition of Safe Harbor. No Form 2210 either.

 

[always_learning]

First I am assuming you are trying to figure out 2023 estimated tax payments and how to avoid penalty, and you have an idea of your 2022 taxes.

The safe harbor rule of paying prior years taxes (or taxes*1.1) in 4 equal installments means that you don’t have to pay more than that installment (1/4) each estimated tax quarter, even if your annualized income figured taxes are higher.

The 22.5% was referring to just the Q1 estimated taxes that must be paid using the annualized income method. It has to be recalculated for each tax quarter with different percentages. I suppose you are trying to figure this from Form 2210, but what you really need to do is learn the annualized income method of figuring estimated taxes. Form 2210 is an after the fact check on that method when filing.

But you don’t even have to do that: If you think 2023 taxes are going to be higher than 2022, just use the simple safe harbor rule of prior years taxes (or *1.1) in 4 equal installments and don’t worry about it. Guaranteed no penalty and avoid a big pre-pay and refund.

Mostly, I'm just trying to understand how it works and playing with 'what ifs' helps me with that.

I was wondering how it would work if someone decided to make a large conversion early in the year and then just had some minor income for the rest of the year as it seemed they would vastly overpay so I used large numbers to make it easier to try to make my confusion easier to understand.

The last bit of your comment really helps break it down for me.

 

[SevenUp]

Huh. TT made it sound like it would be in my favor to use the Schedule AI. I'll rerun it tomorrow without it and see what happens. I thought it *would* be in my favor because I figured the taxes based on what I knew the end result to be + a $1,000 buffer.

AI works best for you if
- your income occurs mostly at the end of the year, and/or
- your withholding occurs mostly at the beginning of the year.

I hadn't seen the case study spreadsheet before. I was just using the tax brackets and configuring the amounts from there as I always have done. Before we started doing Roth conversions two years ago, I was only ever off by whatever the qualified DIVs were, so I'm usually pretty spot on with our taxes. I still do them on paper and use TT as a second look but form 2210 is just nuts.

Thanks for the info... I've got some homework to do tomorrow.

We have our own spreadsheet for tax estimation but also find the case study one useful. It matches what we get on our own and what TurboTax says, so I'm inclined to believe it.

Oh, the 35% was the hypothetical income of 150k x 4 in column on the Sched AI = $600k = 35% tax bracket then they make you compute the taxes on that amount which forces an overpay (in my hypothetical situation).

Good example of why AI probably won't be helpful for you.

 

[d.davis]

We execute a tIRA to ROTH conversion in January roughly 90% of the year total and plan to execute a final ROTH conversion in Dec along with a tIRA conversion with 99% tax withholding to cover the full year withholding to avoid under withholding penalty. Simplifies the paperwork and taxes.

Sent from my moto g power using Early Retirement Forum mobile app

 

[audreyh1]

Paying taxes out of your Roth conversion rather than converting your whole amount (I assume that's what you are describing) reduces what you send to your Roth. If you can pay the Roth conversion tax from taxable accounts that's better. If you can't - you just have to pick the best way for you.

 

[SecondCor521]

I understand how the income and x value decreases with each subsequent period, but I'm annoyed that they are wanting me to essentially overpay if I have a high-earning period a and then not much of anything after that and was hoping there was a work-around for that.

The only workaround I know of is the 99% withholding from a tIRA distribution, as mentioned in post #19 on this thread and elsewhere here from time to time. Or the similar idea of increasing withholding from W-2 or pension sources to compensate for income that doesn't have withholding.

I did let TT compute any penalty for me. Are you saying if I checked the box saying not to compute it that the IRS might not bother with it once someone looked at the numbers?

Yes, exactly. With the minor nit that a human probably won't even look at your numbers.

If it were me, I'd tell TT to not compute the penalty, submit the tax return to the IRS, and expect never to hear from them about that year's tax return.

 

[cathy63]

In my experience as long as your Q1 (and subsequent) estimated tax payments meet the prior year taxes/4 (or (taxes*1.1)/4) it doesn’t matter if you win the lottery in Q4. You don’t have to pay any more quarterly estimated tax even if you still owe a huge amount when you file your taxes the following year. No penalty - the very definition of Safe Harbor. No Form 2210 either.

Yes, that's the safe harbor. I was assuming always_learning wouldn't want to meet the safe harbor for some reason, but if they do, then that's the best way.

Our situation this year is that we sold a rental property and our Q1 income is about 10x our normal full-year income. We'll use the safe harbor this year and just pay a huge tax bill next April without a penalty; but for 2024 we definitely won't be paying estimates equal to our prior year's taxes, so I'll be figuring the estimates pretty carefully for that year.