I paid $0 in federal income tax for 2021. For 2022 I intend to make IRA conversions from Traditional to Roth late in the year. This will make my Federal Income Tax something like $2500 for the year. If I make this conversion in December of 2022 do I need to make estimated tax payments throughout the year? Will I be penalized if I make no estimated payments?
Question on Estimated Tax Payments
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SecondCor521
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You probably qualify for one or both of the following categories, either of which would excuse you from making estimated payments for 2022:
1. Your withholding and refundable credits exceed 100% of your 2021 tax liability (of $0).
2. You're a US citizen and your 2021 tax return covered 12 months (and you had no tax liability).
See General rule 2(b) and Exception at the bottom of column 1 of page 1 and top of column2 page 1, respectively, here: https://www.irs.gov/pub/irs-pdf/f1040es.pdf
There may be a distinction between having a $0 amount due (1040 line 37) and having a $0 tax liability (1040 line 24), so read the instructions carefully.
If you are not excused from making estimated tax payments and you still choose not to, then yes, the IRS may assess an underpayment penalty.
1. Your withholding and refundable credits exceed 100% of your 2021 tax liability (of $0).
2. You're a US citizen and your 2021 tax return covered 12 months (and you had no tax liability).
See General rule 2(b) and Exception at the bottom of column 1 of page 1 and top of column2 page 1, respectively, here: https://www.irs.gov/pub/irs-pdf/f1040es.pdf
There may be a distinction between having a $0 amount due (1040 line 37) and having a $0 tax liability (1040 line 24), so read the instructions carefully.
If you are not excused from making estimated tax payments and you still choose not to, then yes, the IRS may assess an underpayment penalty.
TheWizard
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Just make a single estimated tax payment for the fourth quarter of this year and you'll be fine...
Al18
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Sounds like you should have 10% Federal tax withholding when you make the Roth IRA conversion
Sunset
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Lots of folks like to pay the taxes with non-IRA money, so the entire conversion goes into the Roth.
SevenUp
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Why?
gauss
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Here are a couple of options to handle this. My favorite, by far, is #3 once I learned this trick.
#1) If you do the conversion in the fourth quarter you do have the option to only pay the 4th quarterly estimated payment. The problem with this scenario is that your tax return may be more complicated in that, in the general case, you may have to calculate your income and payments for each quarter separately to avoid a penalty. (Kind of like doing 4 tax returns instead of 1 IMHO). Estimated payments are really designed to be 4 equal amounts sent in throughout the year. Otherwise you risk complicating your tax return.
#2) To solve this problem, I think you might be able to pay the entire estimated payment in the first quarter. The disadvantage would be the feds would have your money longer and this may actually have an economic difference with the rising interest/rates and inflation. You would also need to know the amount that needs to be paid via estimated payments early in the year. I would need to verify if this indeed simplifies your return vs option 1 or not.
#3) You could do what I do. Take a distribution from a retirement account (401k, trad IRA, Roth IRA etc.) that allows you to specify tax withholding. I use Vanguard IRAs for this purpose. Instead of the money coming to you, most of it would go the withholding. Then within 60 days do a roll-over with after tax money back into the account. I usually do this in December each tax year to cover all my Roth conversions. You have to remember that you can't do more than one of these every 365 days. The advantage of tax withholding vs estimated tax payments is that any tax withheld is assumed to have come in uniformly over the year. It doesn't matter which day of the year that you do this (assuming that you observe the 365 day rule.) The other advantage is that the 1099-R will capture the amount of withholding so that you don't have to "remember" that you paid estimated taxes.
-gauss
#1) If you do the conversion in the fourth quarter you do have the option to only pay the 4th quarterly estimated payment. The problem with this scenario is that your tax return may be more complicated in that, in the general case, you may have to calculate your income and payments for each quarter separately to avoid a penalty. (Kind of like doing 4 tax returns instead of 1 IMHO). Estimated payments are really designed to be 4 equal amounts sent in throughout the year. Otherwise you risk complicating your tax return.
#2) To solve this problem, I think you might be able to pay the entire estimated payment in the first quarter. The disadvantage would be the feds would have your money longer and this may actually have an economic difference with the rising interest/rates and inflation. You would also need to know the amount that needs to be paid via estimated payments early in the year. I would need to verify if this indeed simplifies your return vs option 1 or not.
#3) You could do what I do. Take a distribution from a retirement account (401k, trad IRA, Roth IRA etc.) that allows you to specify tax withholding. I use Vanguard IRAs for this purpose. Instead of the money coming to you, most of it would go the withholding. Then within 60 days do a roll-over with after tax money back into the account. I usually do this in December each tax year to cover all my Roth conversions. You have to remember that you can't do more than one of these every 365 days. The advantage of tax withholding vs estimated tax payments is that any tax withheld is assumed to have come in uniformly over the year. It doesn't matter which day of the year that you do this (assuming that you observe the 365 day rule.) The other advantage is that the 1099-R will capture the amount of withholding so that you don't have to "remember" that you paid estimated taxes.
-gauss
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ERD50
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And another, perhaps simpler way to accomplish this, is if OP has any other source that he could withdraw from and have $ withheld.
Any withholding is assumed to have come in uniformly over the year. SS/pensions would be one possibility.
-ERD50
GalaxyBoy
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I also use withholding from the RMD from an inherited IRA to cover my tax payments. Up until this year I was also withdrawing from an inherited annuity over five years so I was able to withhold from that as well. This year I've had to start withholding from DW's small pension and SS.
However, I'm not sure how what's quoted above is implemented. Rolled over from what type of account?
SecondCor521
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Some comments:
1. While technically correct that one should fill out Form 2210 in this scenario and it is a bit like doing four tax returns, in practice if the fourth quarter estimated payment is enough to bring the amount due under $1,000 (or meet any of the other safe harbors), then I'm fairly certain the IRS doesn't follow up. In other words, although I'm nobody's tax advisor here, if you pay enough in a fourth quarter estimated payment to have your April 15th balance due under $1,000, then that will probably work just fine.
2. Yes, one can pay all of the estimated taxes in the first quarter, and this will work even slightly better, because the IRS would definitely not follow up. It does have the disadvantages noted.
3. The technical problem with this - one I also doubt the IRS actually checks on - is that as noted you're only allowed one of these per rolling 1 year period. So if last year you started the rollover on December 19th, then this year you'd have to wait until December 19th to make this year's rollover technically OK. If December 19th is on a Saturday or Sunday this year, or if you're just not exactly on top of things, then this year you might have to do the rollover on the 20th or 21st. Eventually you're going to wrap around and you won't be able to do the withholding in December. Married people who each have traditional IRAs can get around this by alternating who does the withholding/rollover trick, but for single people it would be a problem to consider.
Out-to-Lunch
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But recall that this once-per-year restriction is only on rollovers from tIRAs. Rollovers can be done without limits from 401(k) plans or the like (403(b), 457).
For a rollover in December, the entire estimated tax would be due by January 15 of 2023.
Source:
https://obliviousinvestor.com/estimated-taxes-roth-conversions/
Quote from above:
As a very simplified example, imagine that you have no taxable income whatsoever for the first 11 months of the year. Then in December you do a very large Roth conversion. In such a case, if you make a sufficiently large estimated tax payment by Jan 15 of the following year, you would owe no penalty, despite not having made any estimated tax payment for any of the first three periods.
Can you explain #3 in a little more detail please? I think I am missing something.
Out-to-Lunch
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Here is a link to a post in a thread that describes this in quite a bit of detail. The thread is long and convoluted, but pay particular attention to the posts of Cobra9777, cathy63, and SecondCor521.
I set your starting point to a good spot:
https://www.early-retirement.org/forums/f28/estimated-payments-timing-111924-2.html#post2703901
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