@Divideby7 wrote:
Thank you for the detailed explanation, this is very helpful and insight. I need to check the fees associated if i keep it as is, but i was targeting to do a full conversion and paying the taxes. I wanted to follow up and ask if i should pay the estimated taxes when i do the conversion say around Oct month or should i pay the taxes when i doing taxes next year. I ask since i am expecting some tax credits due to solar program. Also isnt the 12k in taxes an estimate and the actual taxes will be based on my gross income levels for the year?
In general, you are correct that your tax is calculated on your tax return. However, the IRS wants you paying into the system over the whole year (by some combination of withholding from your job and making estimated payments), so if you owe money at the end of the year, you can be assessed an underpayment penalty going all the way back to the beginning of the year, even if you pay in full with your tax return.
OK, here's the problem. The IRS assumes your income is earned evenly over the whole year, even if it is not, and they want to see payments applied evenly over the whole year. That means that if you do a Roth conversion in October, for which $12,000 is due, they want to see a $3000 estimated tax payment made before April 15, June 15, September 15, and January 15, 2026. You haven't made those payments, so you can be assessed a penalty even if you pay the full $12,000 when you make the conversion.
There are 4 ways to avoid the penalty for underpayment.
1. Make the estimated payment in full when you perform the conversion. Then, on your tax return, go to the special situations page and choose to calculate a penalty, even if the program does not think you owe one. Use the Annualized Income method, this is a calculation to show the IRS that your income was not evenly earned over the whole year, but your payments were appropriate to the amount of income in each quester.
2. Owe no income tax when you file because your solar credit is larger than the tax bill from the conversion. If you are expecting a $12,000 (or more) solar credit, so that you don't show tax on your tax return, you should not be penalized for not making an estimated payment.
3. Have $12,000 withheld from your conversion. The IRS assumes that withholding is also spread out evenly over the year even if it is not, so you won't look under-paid. To complete the conversion, send the $12,000 that you set aside for taxes to the Roth IRA instead of the IRS as a tax payment. Tell the Roth IRA this is a rollover. They don't need to know or care that it is part of the other rollover, that gets worked out on your tax return. (If you have $55K, you convert $43K because you have $12K withheld for taxes, but then you deposit $12K as a separate rollover, then it all works out.)
4. Do the conversion in January 2026. The tax payments will be due in 4 quarterly estimated payments, $3000 each in April, June, September and January 2026. Here, the "IRS assumes income is spread out" rule works in your favor. If you owe $12,000 tax on a conversion in January, the IRS will be quite happy to see the payments spread out, and you can invest the money in the mean time to earn a little extra interest.
Now, if you are expecting a solar credit to offset the tax on the conversion, you will want to do #1 or #2, #3 and 4 don't make sense in that situation. If your solar credit will be less than the $12,000, then you should make a partial estimated payments when you do the conversion and then let the credit cancel out the rest of the tax.
