Tax Penalty

[mdktech24]

After completing a ROTH IRA conversion in December (last December), TurboTax indicated that I owe ~$3,000 in California state tax. Because this amount is ~15% of the current tax year’s (2024’s) total tax (~$18,000), hence, I will need to pay a penalty for insufficient tax withholding.

TurboTax calculates this penalty to be $60, which is much less than I expected. I thought the penalty is 8% of the tax owed, which should be $240. My prior year’s (2023’s) California total tax was ~$3,800.

If I pay the penalty plus what I owe would there be any additional interests or charges if I e-file before April 15? I’m assuming that I can pay the penalty plus what I owe when I e-file with TurboTax.

Is it still possible to make the 4th quarter estimated payment even thought I didn’t make any payments for the previous 3 quarters? I under there may be an estimate penalty. Using TurboTax, I compared the penalty for (a) no 4th quarter estimated payment versus (b) paying the 4th quarter estimated payment. Surprisingly the penalty didn’t differ much (a) $60 penalty and (b) $40 penalty. Does this seem right?

[Opus 17]

You would make an estimated payment by January 15.  Then when you file your return, complete a penalty calculation using the "annualized income method."  Do this for both the IRS and the state.  Turbotax may not be automatically recognizing that this is a federal penalty situation, but it probably is.

By default, income is assumed to be earned evenly over the year, but payments are only recorded when they are made.  That means that if you did a $30,000 conversion in December 2024, both California and the IRS will assume that you should have made estimated payments for April 15, 2024, June 15, September 15, and January 15, 2025.   So that $3000 of CA tax should have been paid in 4 equal installments of $750.  Likewise, you probably owe about $6600 of federal income tax that was due in 4 equal installment of $1650.  The penalty is roughly 1% per month of the overdue amount, so 9% on the first $750, 7% on the second $750, and so on (and the same for federal).

The annualized income method breaks down your income and payments (withholding plus payments) by quarters and shows that your income was uneven and the payments for each quarter were appropriate for the income in that quarter. 

So you need to make a CA estimated payment by January 15, and probably a federal estimated payment, and then run both the federal and state penalty calculations using the annualized income method. 

[mdktech24]

Thank you for the detailed breakdown of the penalty and interest. Suppose that I don't make the 4th quarter estimate payment. Then, is the following calculation correct?

1st quarter: 9% (of $750) = $67.50

2nd quarter: 7% = $52.50

3rd quarter: 5% = $37.50

4th quarter: 3% = $22.50

Total penalty = $180.00

Is this penalty based on the assumption that I will file my tax return and pay the penalty by April 15, 2025?  What if I e-file and pay the penalty by February 15, 2025?

Fortunately for I don't have a federal penalty because I had withheld enough tax when I did the Roth conversion. 

[mdktech24]

As a follow up: how to I "run both the federal and state penalty calculations using the annualized income method"?   Would TurboTax be able to perform these calculations automatically?

[VolvoGirl]

You can go to Federal Taxes tab or Personal tab, under Other Tax Situations and select Start by the Underpayment Penalties. You will answer a series of questions that may reduce or eliminate the penalty. Or you can elect to have the IRS figure the penalty for you.  It's form 2210.

It's under

Federal or Personal (for Home & Business Desktop)

Other Tax Situations

Additional Tax Payments

Underpayment Penalties - Click the Start or update button

If you have the desktop program you can switch to Forms Mode (click forms in the upper right (left for Mac)) and open the 2210 form.  If the 2210 doesn't show up in the left column, click on Open Forms at the top of the left column.  Type 2210 in the search box and open the 2210 form.  Check box C to let the IRS calculate it.

I don’t know about state.  If state has it would be on the State tab probably when you go through the state review.

[Opus 17]

@mdktech24 

The penalty is calculated from whenever you owed to whenever you pay.  So if you only pay when you file your return on April 15, 2025, you would owe 12 months on the missed April 15, 2024 payment, 10 months on the missed June payment, and so on.  

You should also review the penalty rates at the FTB.  My assumption was using IRS rules.  It looks like the FTB is a bit more harsh, they will charge you 5% of the missed amount, plus 0.5% per month for every additional month, plus 8% APR on the entire missed amount plus penalties.   That would mean your missed April 15, 2024 payment could accrue 11% as a penalty and 8% interest, for a total of approximately $142.  Lower amounts for the rest since they were owed shorter amounts of time.  

https://www.ftb.ca.gov/pay/penalties-and-interest/index.html

https://www.ftb.ca.gov/pay/penalties-and-interest/interest-and-estimate-penalty-rates.html

For a conversion made at the end of the year, you really should make your payment by January 15, 2025 and then use the annualized income method to compute the penalty, it should almost completely eliminate it. 

[Opus 17 · Accepted solution]

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@mdktech24 wrote:

As a follow up: how to I "run both the federal and state penalty calculations using the annualized income method"?   Would TurboTax be able to perform these calculations automatically?

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If you had federal withholding, that cover the IRS because withholding is also assumed to be spread out over the whole year, so the withholding matches the income.  For the state, if you are not offered a penalty calculation automatically, it should either be in the list of state-specific additional taxes and credits, or under "other tax situations."