Estimated tax penalty on December Roth rollover

[kkarhi]

Hi,

I’m retired, and living mostly on SS and savings in a money market account.  I got 2019 Turbotax, and punched in approximate numbers, and got zero tax for this year.  But my wife had a MRD this year and I’d like use it to pay the tax on a Roth rollover.  But when I added that into Turbotax, it told me I owed an Estimated Tax penalty.

I looked at an IRS publication and there it said that the estimated tax is not needed to be paid until I have some estimated tax income.  So what is that, is SS included in it (I also have some bank interest and investment income)?  If I do the rollover in December, and pay my 4th quarter estimated tax, as defined in my 2018 tax return, by January 15, will the penalty still apply?  Turbotax did not give me such an option.

[VolvoGirl]

Her RMD distribution will be taxable.  If your total income is over a certain amount then part of your SS becomes taxable.

Up to 85% of Social Security becomes taxable when all your other income plus 1/2 your social security, reaches:

Married Filing Jointly: $32,000

Single or head of household: $25,000

Married Filing Separately: 0

[dmertz]

By default your income is treated as having been received uniformly throughout the year, so an estimated tax payment made near the end of the year will not cover the portion of your income that is treated as having been received in an earlier quarter.  To avoid having a large amount of income received near the end of the year has having been received earlier in the year you must perform the onerous task of annualizing income on Schedule AI of Form 2210.  That way you'll reduce or eliminate underpayment penalties for the earlier quarters of the year.  Annualizing involves manually dividing up all of your income, deductions, tax payments and credits among the four tax quarters.

[kkarhi]

So I removed my ROTH rollover from Turbotax, and looked at 2210AI.  I then added the rollover, and went back and put the previous numbers to the first three columns of line 1.  In column four (for the whole year) I put the new number from 1040, including the rollover.  That got my penalty to lower to one half of what it was.  So that helps.

My question of course was if I could avoid the penalty altogether by paying the fourth estimated tax payment, due Jan 15.  I guess the answer is no, as 2210AI is still saying I had income even in the first quarter of the year, due to SS, bank interest, and dividends.  I was hoping that that income would not count as the tax due to them will be zero.

[dmertz]

If you have a traditional IRA or traditional account in a qualified retirement plan there is a way that you can manufacture tax withholding late in the year that will apply uniformly to each tax quarter by default, essentially equivalent to retroactive estimated tax payments.  You can take a distribution from the traditional account, have the majority of it withheld for taxes (some custodians limit you to applying no more that 99% to taxes), then complete a rollover of the enter gross amount of the distribution to a traditional IRA using the funds that you would otherwise be using to make the Q4 estimated tax payment.  This would avoid the need to annualize.  The only concern is that you are only allowed one rollover from a traditional IRA to a traditional IRA in any 365 (or 366-day for leap years) period.

Also consider any underpayment penalty you might have for state taxes.  However, certain states treat tax withholding as paid when received, so there in those states it's not possible to manufacture retroactive tax payments.

[kkarhi]

Wow, that sounds complicated.  Do you have any links that would explain that strategy in detail?

[macuser_22]

It's really simple.

1) Any tax *withholding* is automatically deemed by the IRS to be evenly applied for the entire year so there is no need to try to do annualized income for estimated tax if withholding covers the tax.   The withholding can be on the last day of the year and it still applies to the entire year.

2) A Traditional IRA distribution can (if the financial institution allows it) withhold up to 99% of the distribution for tax which is sent to the IRS and applies to the years withholding.

3) As long as you have not done a previous IRA rollover in the past year, then within 60 days you can roll back the entire amount of the prior distribution.  If anything was withheld for tax, that amount can be made up from other funds so that the entire amount is rolled back. (The 'other funds" is the money that was withheld and you would have used to pay the estimated tax.)

4)  The amount withheld will then either be returned to you as a refund or apply to your  other taxable income.

This little "trick" just takes advantage of the difference between estimated tax (which applies to a quarter unless annualized) and tax withholding that is automatically annualized.

(Same amount of tax paid but treated two differed ways).

[edited for clarity]