How much penalty do I have to pay for my Roth IRA conversion when doing tax filing?

[JohnnyTRZ]

Hi, I just did a Roth IRA backdoor conversion in Jan. 2023 after I changed job.  I have a normal paycheck tax withheld every month now.  How much penalty will incur when I file the tax return and pay the additional tax (I will probably owe $21K federal and $5K  MA income tax for this conversion) in April 2024?  How can I avoid this late payment penalty?

[Opus 17]

To minimize your federal penalties, make estimated payments of $5000 now, June 15, Sept 15, and January 15, at www.irs.gov/payments (best to be a few days before each deadline).  Your first estimated payment was due April 15, so it's 1 month late, which could result in a penalty of 1%, if the IRS assesses it at all.  Making the other estimated payments so that you owe less than $1000 net when you file in April 2024 will eliminate any other penalties.  I assume the rules for MA will be similar.  Alternatively, you could add extra job withholding by submitting a new W-4 to your employer, so that you pay at least $20,000 extra by December 31. That might be $2500 per month, or $1250 per check if you are paid biweekly or $625 per week if you are paid weekly.  

If you make no estimated payments, the penalty will be approximately 1% per month of the amount owed, figuring that you owed $5000 starting in April, $10,000 starting in June, $15,000 starting in September and $20,000 starting in January, up to whenever you pay.  The actual penalty is 0.5% per month penalty, plus interest--interest is a variable rate and is around 0.5% per month but since the federal reserve has been increasing interest rates, that is probably gone up too. 

[fanfare · Accepted solution]

Unless you choose Option D,

Form 2210 requires evenly spread Estimated Tax installments.

What is your 2022 tax ?
If your estimated tax + withholding is each period 25 % of that amount( x 1.10 if your AGI is over 150,000)
you can avoid an underpayment of estimated tax penalty in 2023.

This is the prior year's tax rule for estimated tax.

HOWEVER,

you have missed the first estimated tax payment deadline of April 18th.

[Xian2]

I am planning to do a roth conversion in August this year, and will have a similar high tax due

is it correct just do some prepayment of tax by Sep15 to avoid any penalties later?

we have been retired for 4 years and got refunds of the last few years of return.... maybe that matters for some rules for penalty calculations?

thanks

[Opus 17]

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@Xian2 wrote:

I am planning to do a roth conversion in August this year, and will have a similar high tax due

is it correct just do some prepayment of tax by Sep15 to avoid any penalties later?

we have been retired for 4 years and got refunds of the last few years of return.... maybe that matters for some rules for penalty calculations?

thanks

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I don't know exactly how to do this.  @Critter-3  @VolvoGirl  @Hal_Al 

In general:  

Because the IRS normally looks at income as if it was averaged over the whole year, they will expect to see equal installment payments for the Roth conversion in April, June, September and January.  The "annualized" method looks at your income quarter by quarter, and as long as you pay the right tax for each quarter, you shouldn't get a penalty.  You will want to make a payment before September 15, you can do that at www.irs.gov/payments. 

If you look at form 2210, option C says "Your income varied during the year and your penalty is reduced or eliminated when figured using the annualized income installment method. You must figure the penalty using Schedule Al and file Form 2210."  That's what you will report at tax time to try and get the IRS to eliminate the penalty.  Someone else should be able to walk you through it in the program. 

[NCperson]

@Opus 17 your explanation is correct.  I run into this myself. 

The EASY way to avoid all the hassle is to pay the Conversion $$$$ times your tax bracket by Sept. 15.  Just pay it as an estimate at the IRS (and State if necessary) website. 

Alternatively, filling out Form 2210 and checking Box C indicates "lumpy income"  when completing your 2023 tax return.  It will minimize any penalty (and might eliminate it). 

Form 2210 and 2210ai is a pain because in effect you have to determine your income for each of the 4 periods of the year (YTD March, YTD May, YTD August and then of course the total year).  It's a lot of math and a big spreadsheet to determine when which income is received when.  If you get a lot of dividends for varying pay dates - what a pain!!! 

if you are not concerned with the cash flow and lost interest between Sept 15 and April 15, just pay it in Sept.  Another approach is do the conversion on Sept 1 as the estimated payment is not due until Jan 15.  (note above the Sept 15 estimate is predicated on YTD August income 😀) 

[Xian2]

sounds like doing the 2210 is going to be too painful - if you have to be accurate for this

so trying to understand worst case and best options

my scenario, convert 60k to roth in Aug, taxbracket 22%, if I file taxes next April - that's 9 months... so max penalty if not paid estimates is 60000 *0.22 * 1% * 9 = 1188? 

how does the penalty change if I pay 60000 *.22 to IRS in August?  

or if I do whole conversion after Sep 15 and pay full taxes owed then in Sep

[NCperson]

using your math: 

<<max penalty if not paid estimates is 60000 *0.22 * 1% * 9 = 1188? >>  it wou.ld be times 7 (Sept --> April). and the current annual interest rate the IRS is charging is 7%. 

<<how does the penalty change if I pay 60000 *.22 to IRS in August? >>

should eliminate it. 

or if I do whole conversion after Sep 15 and pay full taxes owed then in Sep - same thing - if you do the coversion AFTER Aug 31 (not Sep 15), then the estimated payment is not due until Jan 15 in any event, so using your math: 3 months times 7%/12 *60,000*..22 or $231

chances are any underpayment will be even less than your worst case due to what is called 'safe harbor' which is based on how much tax you paid in the prior year (2022).  but let's not go there - you have your 'worst case'. 

[Critter-3]

The following is the general “safe harbor” rule that you could use  since you know exactly what the 2022 tax liability was ... 

You must pay estimated tax for 2023 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2023 after subtracting your withholding and tax credits.
2. You expect your withholding and tax credits to be less than the smaller of: 
   1. 90% of the tax to be shown on your 2023 tax return, or
   2. 100% of the tax shown on your 2022 tax return. Your 2022 tax return must cover all 12 months.

Note: If your AGI for 2022 was more than $150,000 ($75,000 if your filing status for 2023 is married filing a separate return), substitute 110% for 100% in (2b)

[Opus 17]

@Xian2 

If you don’t use form 2210 with the annualized method, then your penalty would be calculated as follows:

The tax due on $60,000 would be $13,200, divided into four equal installments is $3300 each. The IRS will assume that $3300 was due April 15, June 15, September 15, and January 15, 2024. If you pay the entire $13,200 before September 15, you will still be overdue by $3300 from April 15 through September and you will be overdue $3300 from June 15 through September. There is a penalty of 0.5% per month plus a variable interest rate, which is currently about 7% APR, for simplicity sake lets call it 1% total per month. That means the penalty would be $33 x 5 months for the first missed installment plus $33 x 3 months for the second missed installment, for a total of $264.  

If you don’t make any estimated payment until you file your tax return in April, 2024, you would be overdue $3300 for 12 months, another $3300 would be overdue by 10 months, another $3300 would be overdue by 7 months, and the last $3300 will be overdue by 3 months, with each overdue amount accruing a penalty of 0.5% per month plus interest at 7% APR.  (And if the federal reserve bank continues to increase interest rates, the IRS interest rate will also increase.).  Using the IRS default method of penalty calculation, it doesn’t matter when in the year you make the conversion, the IRS will always assume that payments were due in four equal installments on April 15, June 15, September 15, and January 15.

I would not be intimidated by the form 2210 AI method. Using that method should completely eliminate any penalty, as long as you make the complete payment of $13,200 before the deadline for whichever quarter you perform the conversion.  In other words, if you perform the conversion before August 31, the complete payment would be due September 15, and if you perform the conversion after September 1, the complete payment is due January 15, 2024.  However, to be on the safe side and allow for banking delays, I would try to make the payment five days before the deadline.

[Xian2]

this is really helpful

thank you so much

[Critter-3]

I would not be intimidated by the form 2210 AI method.

I agree ... but you need to be prepared if you go this route as the program will not do the required quarterly income calculations for you ... this is something you need to do manually and enter the figures.   If your other income  comes in evenly throughout the year this will not be a difficult thing to manage.