Backdoor Roth Tax Withholding

[Finkster53]

Last year I did a sizable backdoor roth conversion in the 4th quarter and the next day I sent an electronic payment to the IRS for the estimated tax on the conversion using non-IRA funds. After filing, the IRS penalized me for tax underpayment even though I got a significant refund at the final filing. All I could get out of them is that I didn't file the right paperwork (1022 maybe?).  Anyway, what is the proper procedure for making an estimated tax payment on a sizeable backdoor roth conversion.

[VolvoGirl]

Was there a penalty on your tax return line 38?  You needed to fill out form 2210 to eliminate or reduce it.  To show when you made the conversion and when you paid the estimated payment.

Don’t know if you can amend for that.

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

Here is a blank 2210 and instructions.  Maybe you can figure it out by hand to give the IRS.

IRS form 2210

https://www.irs.gov/pub/irs-pdf/f2210.pdf

2210 Instructions

https://www.irs.gov/pub/irs-pdf/i2210.pdf

[Finkster53]

Good info. Line 38 was blank. I contested the penalty and lost. Now it is in appeal. $280 dollars, I'm not losing sleep over it, but I don't want it to happen again. Form 2210 could not be any more confusing. The simple route is to withhold tax money out of the converted roth IRA money. I did that in previous years with no issues and I guess I will do that again.

Thanks much for the quick response.

[Opus 17]

When you do the rollover, try to have the taxes withheld by the broker instead of making a separate payment.

Here's the problem, as simple as I can make it.

The IRS considered income to be spread out over the entire year.  They don't if you rolled over $10,000 all at once or $200 per week.  So they assume the income was spread out over the year, and they want taxes to also be spread out over the whole year.

Now, any withholding is also considered to be spread out over the whole year.  Just like they don't know if you rolled over $10,000 all at once or $200 per week, they don't know if you had $2000 withheld all at once or withheld $40 per week.  So they assume withholding is spread out over the year.  Spread out income, spread out withholding, no penalty.

But an estimated payment is made on one specific day and they know it.  So if your $10,000 income is considered to be spread out over the whole year, they want to see either withholding (also considered to be spread out over the whole year) or they want to see estimated payments in every quarter, spring through winter, even though you only made the withdrawal in winter.  That's why the penalty.  You were under-withheld or under-paid over the year.

One answer is to use the annualized method on form 2201 to show your income was uneven and your tax payments matched your income in each quarter.  The simpler method is to have the taxes withheld by the broker instead of making an estimated payment.

[fanfare]

"When you do the rollover, try to have the taxes withheld by the broker instead of making a separate payment."

If you do this, you are impairing your Roth conversion, the funds go to the IRS instead of the Roth IRA.

Meanwhile, the entire distribution is taxable.

@Opus 17 

[dmertz]

It's likely that the penalty would have been avoided if your filed Schedule AI along with Form 2210 to annualize income.  Absent that, the Roth conversion is treated as income spread evenly over all four of the tax quarters, resulting in underpayment for the earlier quarters.

Unlike tax withholding which by default is treated as withheld evenly throughout the year, estimated taxes are only credited when actually paid.

[Opus 17]

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@fanfare wrote:

"When you do the rollover, try to have the taxes withheld by the broker instead of making a separate payment."

If you do this, you are impairing your Roth conversion, the funds go to the IRS instead of the Roth IRA.

Meanwhile, the entire distribution is taxable.

@Opus 17 

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The entire distribution is taxable no matter what.

Assuming that when you convert (let's say) $10,000, you also have $2200 from another source to pay the tax, then you can make an estimated payment from that source instead of withholding.  But then you must use schedule AI on form 2210 to avoid a penalty.   

Of course, you could also have the $2200 withheld from the distribution, then pay $2200 from your other funds into the Roth IRA as an indirect rollover within.  That accomplishes the tax deferred savings AND having withholding to avoid a penalty.  But you can only do that kind of rollover once per year.