backdoor Roth tax payment procedure

[Username5]

I made several Tira conversions to Roth in '24.  I made IRS "direct payments" online to cover my anticipated taxes on the conversions.  This totaled a 6 figure payment and were listed in TTax  "Tax Payments Worksheet", Lines 18b & 18c.  These payments were made at the time of the conversion.  The payment is reported on the 1040 line 25c as a withholding.

The mutual fund company did not give me any tax forms for these transactions.  I have reported the conversions on the 8606-T (and S). 

My problem is that the IRS sent me a check for the 6 figure amount as an 'overpayment'.  I marked this check void and returned it with a letter of explanation that it was for tax on the conversion.

The IRS replied to my letter saying in part "Our system shows tax of X and withholding of Y".  The amounts X and Y are correct and listed on my 1040 line 24 and 25d.  The letter further states "We received two payments of 'A' & 'B' on <Date, 2024>."  A & B match the numbers reported above on lines 18b & 18c.  And they sent a new 6 figure check as a refund.

IMO They seem to be confusing withholding with direct payment.  Perhaps I did not place the direct payment numbers in the correct spot on my return.  Whatever the case it appears I will get nowhere returning the 6 figure check again.  I'd love to keep it but I would not love being discovered and explaining this stuff.

I tried calling them when I received the first check and after 6 hrs of getting no where not getting someone to help me I gave up.  

If there is a glaring error in reporting with the info I gave, I will file an amended return.  Assuming TTax put the numbers in the right spot, I am looking for advice on how to correct this apparent error on the part of the IRS.

[Username5]

OP here.  The subject is misleading.  It is not a backdoor Roth.  It is a Conversion from Traditional to Roth, I am a retired person who already is doing RMD's.  I tried to edit the original post but was unable.

[baldietax]

I don't know all the mechanics but maybe their system hasn't caught up with what you filed as withholding wasn't actually withholding, and instead they are showing direct payments which are classified as estimated taxes.  So until they figure out they don't have the withholding they think you overpaid? - something like that.

the issue may be in your return, these payments shouldn't be "withholding" they are estimated taxes.  you should also have a 1099-R for the conversion with the appropriate coding and withholding, if you input the 1099-R into TT using your payments as withholding that's probably where problems began.  you may also then need to file Form 2210 Annualized Income method to line up the income/tax liability timing with the ES payment timing otherwise you could get an underpayment penalty especially if your conversions/payments were later in the year.  by entering it as withholding this issue may have been bypassed as withholding is considered "timely" whenever it happens.

doing a Roth conversion with withholding results in the tax being paid out of the IRA distribution not your non-retirement funds so less goes into your Roth, so I think you did it correctly with estimated tax to payment to the IRS.  Tho, if you have this situation again be aware of the estimated tax safe harbor, you only need to pay 100% of last year's tax (110% if AGI > 150k) or 90% of current year's tax whichever is smaller.  If you intend a very large Roth conversion then you may be better off paying ES to make 100/110% of last year's tax, as long as that is paid evenly and quarterly, then you don't need to pay the balance of the tax until final filing.

not a CPA/Expert just my quick thoughts from what you've described.

[Username5]

@Balditax:  Thanks, but near as I can tell I did the TTax 1099-R correctly.  There is a withholding for my RMD and no more than that.  The only place in my filed return that shows the correct numbers withheld from the conversion (withheld from outside funds) is on the TTax page "Estimates & Other Taxes" -> "Other Income Taxes".   The amount I withheld when using "Direct Pay" had a cushion and I made the payments within 2 days of the conversion.  I kept copies of the transaction confirmations to avoid underpayment penalty.  TTax form said I did not need to file a 2210 so I didn't.  The IRS has my return because they have mentioned all of the correct amounts.  And, because I paid the direct pay my taxes paid are well over 100% of prior year (which is likely why TTax said I didn't need to file a 2210), but you raise a good point as I am going to convert more this year and probably won't be able to cough up enough outside cash to meet 100% of this year.   I'll try to remember this next year.

My 1099 is "taxable amount not determined" and coded IRA 7 which is correct.  It shows the total amount distributed without mention of the conversion.

I guess I simply need to send another letter to IRS spelling out "their error" but they seem to be set on giving me back my tax payment anyway.  Maybe the "Operations Manager" has been in the seat only since Jan.

[baldietax]

ok when you do directpay you have to give a reason from the drop down, what did you use for that as there is no option to classify that as "withholding", did you use "estimated tax".  Then in TT I'm guessing you used "other income taxes" / "withholding not already entered on a W-2 or 1099"? - as opposed to the "estimates" category.

[Username5]

In IRS Direct Pay I flagged it as Estimated Tax.

In TTax it is entered under "Tax withholding that you haven't entered yet", Federal withholdings.  I did not enter them under Estimated Taxes because I did not file a form 1040ES.  I can see this may be a possible cause for my problem.

And since I don't have wages I don't have normal withholdings.  My normal withholdings are determined by a % that I elect when setting up my RMD and pension plan payments.  I've never in 20 yrs of retirement filed a 1040ES as I've always made sure I was covered by withholdings of the individual payments.

But my real problem is how to get the IRS to accept that I don't deserve to have a 6 figure refund which is quoted here "We changed your 2024 form 1040-SR to match our record of your estimated tax payments,".  In other words, they see it as an estimated tax payment.

So on my return, I entered the amount on line 25c and apparently I should have entered it on line 26.  Is that a correct assumption?

[baldietax · Accepted solution]

I think that's the issue, the payments should be on line 26.  With electronic payments you don't file a 1040ES per se, no voucher required, making a payment electronically designated as Estimated Tax is a 1040ES.

I don't know enough about any special IRS dealings in this situation, but I am guessing you will end up needing to amend your return to designate your payments as estimated tax instead of withholding and that will presumably bring everything into balance at the IRS.  Sounds like you are correct not to cash the check, presumably the IRS would at some point catch up on the withholding mismatch and then say you underpaid!

The biggest issue with the amendment will probably be the underpayment penalty - when you switch to ES, even tho you paid the full amount of tax, if you didn't pay ES evenly each quarter then likely by default you will see a large underpayment penalty; it's assumed the income/tax is incurred evenly thru the year and the withholding/estimated tax needs to line up with it.  The penalty calculation is done quarterly not annually, so you can be fully paid by year-end or even have a refund, but still have an underpayment for Q1, Q2 etc.  Withholding is treated differently, it's assumed to be 'timely' with the associated income so I think that's why it didn't trigger a penalty before.

If you on TT desktop then in Forms mode you can double-click on the 1040 penalty line and again on the worksheet to bring up Form 2210 with the underpayment calculations. 

For your situation tho, if you paid ES when you did the conversions, you will probably need to adopt the Annualized Income method on Form 2210 to show that the ES lined up with the correct quarterly timing for the income, which will significantly reduce if not eliminate the penalty.  You'll need to provide AGI, Cap gain info thru the year for 3/31, 5/31, 8/31.  This is under Other Tax Situations / Underpayment Penalty.  You may have the same situation with your state tax.

Just a quick example to illustrate, assume no other income and you needed to pay 100k to meet safe harbor, but paid 50k in Q3 and 50k in Q4 for 2 Roth conversions in those quarters.  Without the AI method, then by default the 100k tax needs to be paid 25k per quarter.  So in this situation you would have 25k underpayment from Q1, 25k underpayment from Q2, those underpayments are eliminated in Q3 when the 50k is paid and the penalty stops accruing, but now you are still 25k underpaid in Q3 until the final payment in Q4.  Overpayments earlier in the year will carry forward and eliminate underpayments in later quarters, but no amount of overpayment later in the year will eliminate underpayments in earlier quarters, tho will stop the penalty interest from accruing.

For 2025 if you're planning the same level of conversions but didn't pay ES for Q1 you can take the same approach and pay ES along with the conversions and file AI method again for 2025.  Or figure your quarterly ES payments based on either 100/110% of 2024 or 90% of 2025 tax, tho you may still get some penalty for Q1 if you missed the 4/15 deadline.

You can do the ES calculations under Other Tax Situations / Form W4 and Estimated Taxes and provide 2025 income information to optimize the payments.  If you don't provide 2025 info, TT will generate ES vouchers by default based on 100/110% of your 2024 tax and assumes 2025 withholding is the same as 2024 - so another ramification of your situation is it's possible TT assumed the same large withholding for 2025 and generated ES vouchers much smaller than needed.  Again you don't need these physical vouchers when paying electronically.

Again not a CPA/Expert and not sure all the mechanics of this situation with the IRS, but hope this helps.

[dmertz]

The problem stems from what appear to be several errors you have made on your tax return.

"In TTax it is entered under "Tax withholding that you haven't entered yet""

As baldietax said, estimated tax payments are not tax withholding.  They must be entered as estimated tax payments, not tax withholding.  TurboTax has a separate page for that.

"The mutual fund company did not give me any tax forms for these transactions."

Also as baldietax said, the company is required to issue a Form 1099-R for any Roth conversions.  If you received no such forms, you'll need to investigate that with the company.  If the conversions made in 2024 were not reported to you or the IRS on one or more Forms 1099-R, the IRS will not be aware of this taxable income and will reject the payment of any the taxes for taxable income that is not present on your tax return.  If the company did issue a Form 1099-R, the IRS should have received it from the company, would have detected the underreporting of income on your tax return, and likely would not repeatedly return the estimated tax payment.

baldietax also addressed the issue that, unlike the default treatment for tax withholding, estimated tax payments are credited when actually paid.  Because, by default, income is treated as received evenly throughout the year, if your Roth conversions and estimated tax payments were made late in the year and you do not qualify for one of the safe harbors, you'll likely need to annualize income on Schedule AI of Form 2210 to avoid underpayment penalties for earlier tax quarters.

[Username5]

@baldietax wrote: probably need to adopt the Annualized Income method on Form 2210 to show that the ES lined up with the correct quarterly timing for the income, 

Thanks, I did start the annualized 2210.  I decided making a spreadsheet made more sense to me and used that to make my decisions about how much to use for Direct Pay.  Unfortunately, that doesn't meet the 4 equal payments.  I have used Direct Pay several times in the past but never for the large amount I needed in '24.  It was never questioned, perhaps it did not meet a certain IRS threshold.  Anyway, because of my prior successful use of Direct Pay to beef up my tax payments I simply figured this was "a good way".  Bzzz.  Wrong answer.

Examining my "Filed Return", There is a "Federal Carryover Worksheet, page 2" Line 6 "Tax liability for form 2210" and that has the correct amount shown even though there is no Form 2210 in my filed return.  That worksheet also shows "no penalty".  

I think the most prudent thing is to file an amended return and pay more attention to when I make future conversions.  I have been using large market corrections on the theory it would reduce my tax liability.  What is the saying about being pound foolish?

Thanks for all the great ideas and help lining up my thinking to get this done.

[Username5]

@dmertz:  Thanks for the clarifications.  

On the 1099-R, the company listed my distribution as a single number, RMD + Conversion which is probably the correct procedure.  Looking again at my filed return, 8606 is where I input the amount converted.  My confusion on this point is that the Company did not report a conversion, I did.  I thought the Company needed to file something explicitIy indicating a conversion.  Maybe that is all that is required and I was expecting something that is not required.  Anyway, I'll do an amended return and void out the check they sent and return it, yet again.

Thanks again

[Username5]

And one more point.  The error in my return is, of course, entirely my own fault.

I conflated 'withholding' and 'estimate'.  This is likely because when doing the conversion I had the choice of withholding x% or zero.  I chose zero because I was paying with "outside funds".  However, my brain retained the word 'withholding' and I did not realize that Estimate is a distinctly different concept.  At that point I started looking around TTax for where to enter the 'withholding'.  Oh well, hopefully this lesson will be retained.