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Roth Conversion - timing & tax consequence

I have determined that it may be beneficial for me to do a Roth Conversion sometime in 2021. What I'd like to avoid is any penalty based on under-payment of taxes.

It is my understanding that taxes in the US is a "pay as you go" system and that if your taxes are under-withheld you can pay a penalty. So, if I make a Roth Conversion late in 2021 it will certainly generate additional taxes owed but am I supposed to have been paying some of that additional tax before the actual conversion was made or does making the additional tax payment based on the conversion at the time of conversion avoid a penalty as I described?

 

Another aspect to the question, is it beneficial to start converting some funds now and pay the taxes on the portion converted rather than lump sum later in the year?

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5 Replies

Roth Conversion - timing & tax consequence

Estimates should be made  in the same quarter as the conversion  ... waiting until the end of the year or when you file the return could have penalties added to the balance due.  

 

 

What are estimated taxes?

https://ttlc.intuit.com/replies/3301588

Do I need to make estimated tax payments to the IRS?

PAYING ESTIMATES
For SE self employment tax - if you have a net profit (after expenses) of $400 or more you will pay 15.3% for 2015  SE Tax on 92.35% of your net profit in addition to your regular income tax on it. So if you have other income like W2 income your extra business income might put you into a higher tax bracket.

You must make quarterly estimated tax payments for the current tax year (or next year) if both of the following apply:
- 1. You expect to owe at least $1,000 in tax for the current tax year, after subtracting your withholding and credits. 
 
- 2. You expect your withholding and credits to be less than the smaller of: 
    90% of the tax to be shown on your current year’s tax return, or 
  100% of the tax shown on your prior year’s tax return. (Your prior year tax return must cover all 12 months.)

https://ttlc.intuit.com/replies/3301891

 

How do I make estimated tax payments?

https://ttlc.intuit.com/replies/3301258

 

Can TurboTax calculate next year's federal estimated taxes?

https://ttlc.intuit.com/replies/4242911

 

Can TurboTax calculate the estimated payments for next year's state taxes?

https://ttlc.intuit.com/replies/3301735

Roth Conversion - timing & tax consequence

There can be some weird situations where, if you are underpaid, the IRS can back-calculate the penalty based on spreading out the extra income over the whole year.  But, if you are caught up and don't owe when you file, that situation should never come up.  So I would make sure to pay slightly more than you think you will owe, as you would get the extra back as a tax refund.  Tax for a conversion done from June-August would be due Sept 15; tax for a conversion done after August 31 would be due January 15.

 

I can't think of any particular harm or benefit to making several smaller conversions or one large conversion, unless you have concerns about having the funds available to pay the estimated taxes.

 

Don't forget you likely will owe estimated state tax payments as well.  

Roth Conversion - timing & tax consequence

If you convert $10,000 to a Roth, expect to pay 24% federal income tax or more if you are in a high income bracket.

Therefore, make an Estimated Tax payment of $2,400 (or more) in the quarter when you have the custodian convert $10,000.

Then make an Estimated Tax payment to your State if you have state income tax.

 

As you can see, doing a Roth Conversion can be very expensive if you have taxable income.

 

Now do you still think it is a desirable thing to do ?

Roth Conversion - timing & tax consequence


@fanfare wrote:

 

Now do you still think it is a desirable thing to do ?


That's just silly.  There are a lot of reasons why paying taxes now might be better than paying them later.   The question here is, once the taxpayer has decided to do it, what's the requirement for paying the taxes.  

Roth Conversion - timing & tax consequence

If you can grow your $2,000 Roth IRA into $5 Billion Roth IRA, as Peter Theil did, 

then I agree, yes you should convert.

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