Roth Conversions

[JT521]

Doing a IRA to Roth Conversion. What is best way to pay the tax due on the IRA during the last quarter of 2021. Is there a way to do this without a IRS penalty with outside money? thanks

[macuser_22]

Just pay online at the IRS site that is the easiest way.

https://www.irs.gov/payments   When you file enter it under estimated tax paid to get the credit.

[DanPaul02]

You will not occur a penalty, but will owe ordinary income tax on the money that is converted.  Paying it in the 4th quarter will not give you any advantage, but you do that if you wish.  You would just make an estimated tax payment or ask the financial institution to withhold taxes for you.  

Here is how to make an estimated payment.

[macuser_22]

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@DanPaul02 wrote:

You will not occur a penalty, but will owe ordinary income tax on the money that is converted. 

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There might indeed be an underpayment penalty depending on the following:

You may avoid the Underpayment of Estimated Tax by Individuals Penalty if:

• Your filed tax return shows you owe less than $1,000 or
• You paid at least 90% of the tax shown on the return for the taxable year or 100% of the tax shown on the return for the prior year, whichever amount is less.

The estimated tax should be paid it the same quarter that the conversion occurred, however the IRS has no way to know when the conversion  took place as the date is not reported by anyone to the IRS.

https://www.irs.gov/payments

[fanfare]

paying the tax with outside funds means more money growing tax free.

unless of course you have no other funds.

[Opus 17]

I guess the question about outside funds means, as an alternative to withholding?  Suppose you convert $10,000 but have 25% withheld. That means that you are really only converting $7500 and the other $2500 counts as a distribution, which will be subject to both regular income tax and a 10% early withdrawal penalty unless you are over age 59-1/2.  To prevent this from happening, you would have to find $2500 of outside money and send it to the Roth IRA custodian within 60 days, for it to count as part of the conversion.

Or, do the conversion with no withholding, and then find outside money to pay the $2500 of tax. This way, you won’t owe additional tax for early distribution because you have converted the entire amount. I think this was what you were asking about.

Now the question is, how and when to pay the additional tax. To pay the tax directly to the IRS, the best way is to use the IRS website www.irs.gov/payments. Select “2021 estimated taxes“ from the pulldown menu as the reason for the payment.  As far as when to pay, if the conversion happens before the end of August, an estimated payment is due September 15. If the conversion happens after September 1 and before December 31, an estimated payment is due January 15, 2022.   If you don’t make the estimated payment, you may owe an underpayment penalty even if you pay in full when you file your tax return, because the tax system is supposed to be pay as you go. If you pay too much in estimated taxes, the excess will be returned to you as part of your tax refund.

[tinaeva]

I did a 4th quarter Roth conversion and paid an estimated tax payment at the IRS website, but I can't find any place in Turbotax to enter the estimated tax payment that I made. How do I do that?

[RaifH]

If you are using TurboTax Online, to enter the estimated tax payment you made:

1. In the Federal > Deductions & Credits portion of your return, scroll down to Estimated Tax Payments.
2. Click Start/Revisit next to Federal estimated taxes for 2021.
3. Click Yes.
4. Enter your fourth-quarter payment amount and date.

If you are subject to an underpayment penalty, you may want to visit the Underpayment penalty section at Federal > Other Tax Situations > Additional Tax Payments. If you allocate a majority of your income to the 4th quarter due to the Roth conversion, this could reduce or eliminate the penalty.

@tinaeva

[tinaeva]

Hi. Thanks for the reply. I have the desktop version of TTX Deluxe. 

What I did see by going to forms, was a line on the 1040 where I could enter estimated taxes. So I used that line. There doesn't seem to be any question in the step-by-step version that enables you to input estimated taxes. The only thing I could find was a question about "changing your W4" which is not relevant as I don't normally pay ETs.  I appreciate your answer.

[Opus 17]

“Estimates and other taxes paid” is also on the deductions tab of the desktop version.

[tinaeva]

Thanks. I wasn't using the tab for everything, just the one where I choose what to enter, so didn't see the estimated taxes tab since I've never paid them before.

[GregorL]

Even if you do make that full Estimated Tax Payment in the same quarter as the conversion, if that quarter is the 4th quarter (or possibly also in the 3rd quarter), you may still get hit with a penalty for underwithholding.  I know it makes no sense at all, but the IRS treats Estimated Tax Payments differently than they do tax withholdings.

For the reasons already mentioned, the withholding method is not always optimal for Roth conversions, so you are usually left with the Est. Tax Pmt method.  The conversion amount is considered to be spread evenly over all 4 quarters of the year since the conversion date is not reported to the IRS and most software doesn't seem to be able to get around that.  As such, 1/4 of the conversion amount is assumed to be in each quarter, but your Est. Tax Pmt was in the 4th (or 3rd) quarter.  This means you look to have underwithheld in the earlier quarters.  FYI, if you did use the withholding method, it too would have been spread evenly across all 4 quarters and there should be no issue and no penalty.  An IRA distribution would be similarly problematic if you paid by Est. Pmt, but averted if you used withholding instead.

The only resolution seems to be to opt to Annualize your income using Form 2210.

[DawnC]

The IRS levies underpayment penalties if you don't withhold or pay enough tax on income received during each quarter.  Even if you paid your tax bill in full by the April deadline or are getting a refund, you may still get an underpayment penalty.

To annualize your income, search for annualizing your tax (use this exact phrase) to be taken to the underpayment penalty section in TurboTax.

See the example in this FAQ.  @GregorL