Get your taxes done using TurboTax

Hello Opus 17, I have asked questions to your suggestions in blue italics. Thank you for taking the time to read them.

If you have income tax withheld from the conversion, you will avoid any penalty related to the conversion.   Withholding is treated as if it was spread out over the whole year.  

I’ve been told that it’s best to pay the taxes on a Roth conversion out of an after-tax account so that all of the conversion funds can continue to grow tax-free. That would be my preference.

If you don't have taxes withheld, you need to follow two steps.

1. Make an estimated payment at www.irs.gov/payments before January 15.

I can make an estimated payment before Jan. 15.

2. When preparing your tax return, enter the penalty interview (even if not automatically prompted) and prepare the penalty form 2210 using the "annualized income" method.  You will need to list your income and tax payments by quarter, and show the IRS that even though your tax payments were not evenly distributed over the year, they were appropriate for the amount of income you received in each quarter.   (Or in your case, you may end up showing that you were $250 short each quarter, but not thousands short.)

I used TurboTax’s Annualized Income section, but I’m not sure I did it correctly. It’s very confusing. Here’s what I did. Please tell me if it is correct:   

In the Annualized Self-Employment Earnings section, I entered my salary by period (I have to complete form C, but I did not reduce my salary by business expenses). Only the first field is a 3 month (quarter) period. The next fields are 5 months, then 8 months, then the whole year. TurboTax computes a figure for the last field. For the first field I entered my salary for 1-1 to 3-31, for the next field I entered the same amount but added my salaries for the months of April and May. I did a similar thing for the field 1-1 to 8-31. 

For the next section, Annualized Adjusted Gross Income, I entered my AGI, which in my simple case includes salary plus interest income, LESS my only deduction, the self-employed health insurance deduction. TurboTax instructed me to leave out one half of my self employment tax. My health insurance premiums and my interest income were about the same every month, , so I just divided those both by 12 to get a monthly amount. I entered amounts in the Annualized Adjusted Gross Income fields in the same way I did for the Annualized Self-Employment Earnings section. Did I do this correctly? The underpayment penalty result was only $21, which seems way too low. 

You can also have the taxes withheld by making the conversion in two steps.

1. Make a direct rollover conversion with taxes withheld.

2. Within 60 days, send a payment to the Roth IRA custodian in the amount of the missing taxes, telling them this is also a conversion.

For example, to convert $10,000, you could directly convert $10,000 with $2000 withholding.  Then, within 60 days, send a check for $2000 to the Roth IRA telling them this is also a conversion.  (They don't need to know or care that it is part of the same conversion.)  In other words, since you must have the $2000 on hand anyway to pay the tax, have the tax withheld and deposit the tax money as part of the conversion instead.  This removes the need for the annualized income method to avoid a penalty.

So in this case I’m still using converted funds to pay the tax, right? And would this then count as a $12K conversion?

If you don't have money on hand to pay the tax, then do the conversion with withholding but don't top it off.  If you convert $10,000 and you think you are in the 12% bracket, have $1200 withheld.  You will tell turbotax that you converted $8800 and "did something else" with the $1200.  The withholding will be to your credit on your tax return. 

If you had extra withholding, to cover the SE tax, that would eliminate that penalty as well.  For example, if you are single, with self-employment of $14K, and the standard deduction is $19K, you could convert up to about $48K and stay in the 12% bracket.  (or convert just $5K and pay nothing).   If you converted $48K, you would have $5760 withheld.  If you added the SE tax and asked for $5900 of withholding, that would cover everything.

I have questions about the two paragraphs above as well, but I’ll let you respond to the other questions first. Many thanks again.