Failure to Pay Estimated Taxes due to IRA to Roth IRA conversion

[cdwestlund]

I converted part of my IRA to a Roth IRA at the very end of December 2023. I paid the taxes on this conversion (about $3000) in April 2024. I got a penalty from the IRS because I didn't pay estimated taxes starting in April 2023 onwards for this conversion that I didn't even make until December 2023.  I purposely waited until the end of December 2023 to do the conversion so that I make sure I don't convert too much and end up in a higher tax bracket. How can I prevent this from happening next year, especially when I'm not sure how much I want to convert until the very of the year?

[dmertz]

Since it appears that you did not meet the safe harbor for either 100% (or 110% for those with higher AGI) of your 2022 tax liability or a balance due of less than $1,000 based on the tax payments for 2022 that you did make, you needed to make an estimated tax payment by January 15, 2024 to avoid underpayment for the fourth quarter of 2023.  With all of your tax payments entered into TurboTax, TurboTax would have informed you that you would be subject to an underpayment penalty.

Because your income is treated by default as received evenly throughout the year while estimated tax payments are only credited when actually paid, even if you had made an estimated tax payment by January 15, 2024 you would likely need to annualize income on Schedule AI of Form 2210 to avoid a penalty by treating income as received when actually received.  The need to prepare Schedule AI  can be avoided either by having a sufficient amount withheld for taxes to cover the amount required to meet a safe harbor, (unlike estimated tax payments, tax withholding is treated as having been paid evenly throughout the year) or by making estimated tax payments for each quarter of the year.  For example, you could have allocated some of your December 2023 traditional IRA distribution to tax withholding, then within 60 days substituted other funds to complete an indirect conversion to Roth of the portion withheld for taxes.  This would have given you until at least late January 2024 to have come up with the funds to complete the conversion as well as avoiding the need to file Schedule AI.

[SteamTrain]

@cdwestlund 

(For your 2024 taxes)

1) One way would have been to go ahead and pay 4-qtrs of $750  this year...assuming you were going to convert the same amount....then if you converted less, you'd get some refund.  But too late for that now.

2)  The next more complex way, is to convert in December, then pay a lump as a single 4th Qtr Est payment before 15 Jan of 2025.    That way may still end up with a penalty...BUT...you minimize or eliminate it by going thru the underpayment penalty calculations on the "Other Tax Situations" page in the TTX software.  In that section, you can delineate all your income by quarter (pensions, wages, dividends, interest, Cap gains etc), thus showing the converted amount occurred in the last quarter, and that you paid the approx amount due for that last quarter.  That Annualized Income method limits...or eliminates the penalty.   That creates a form 2210/2210AI which shows the IRS all that more detailed information. 

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#1 is easier, # 2 can be a bit of a pain...and I've only done it once for some major unexpected income, and won't do it again for a penalty under ~$50.

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If you are going to do #2 this year, it's a good idea to start a spreadsheet now showing all your types of income every month...so that you can later create the quarterly amounts more easily.  (AND the quarters are 3mo, 2mo, 3mo, 4mo).   Keep track of your deductions too if you itemize, because those have to be reported by quarter too

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You can see what's in the form 2210/2210AI in Forms Mode if you are using Desktop software.

Or

Go to the IRS forms, search for the form 2210, Open that PDF and scroll down to page 3 to see the 2210AI form setup.

Forms, Instructions and Publications | Internal Revenue Service (irs.gov)

[NCperson]

@cdwestlund you can amend your 2023 tax return and complete form 2210 and form 2210ai.  Be sure to check option C.  it's not going to eliminate the penalty (because you didn't may a payment in Jan 2024), but it will permit you to indicate your 2023 income as "lumpy" and you didn't owe estimated taxes in Apr, June and Sept 2023. 

the forms are a 'pain' - because in effect you are filling out your tax return by quarter and determining how much income was generated in that specific quarter.   

how much was the penalty? it may not be worth the time or effort to amend.