Extra Withholding due to Roth Conversion?

[mooncake]

This year, we converted some of our IRA funds to a Roth IRA, amounting to about 15% of our income from last year. We're concerned about potentially facing a penalty for underpayment of estimated taxes. In our situation:

1. Does the Safe Harbor rule apply if we increase our W-4 withholding to 110% of the tax shown on last year's return?
2. When considering the previous year's tax for the Safe Harbor rule, should we refer to the total tax owed (Form 1040, line 24 "total tax") or the total tax withheld last year (Form 1040, line 33 "total payments")?
3. Is it necessary to withhold the tax in the same quarter as the Roth conversion, or can we increase the withholding later in the year?
4. Can we increase W4 to withhold 50% of income as tax? 

[SusanR2]

Hello!  To answer your questions:   If the Adjusted Gross Income (AGI) on your previous year's return is over $150,000 (over $75,000 if you are married filing separately), you must pay the lower of 90% of the tax shown on the current year's return or 110% of the tax shown on the return for the previous year.  To determine the amount, you look at the total tax due/liability, not total tax withheld.   It is best to pay taxes throughout the year as opposed to all in one quarter.  You can choose to make a payment online and designate it as an estimated payment for 2024 so that you get some extra tax paid in during the quarter of the conversion. 

Here is a link to a great article that you can review regarding when and how much to pay if you have additional income and will owe tax:  

https://turbotax.intuit.com/tax-tips/small-business-taxes/estimated-taxes-how-to-determine-what-to-p...

(This article is not only for those in business, but is a great discussion of estimated payments generally.)

Here is another link regarding how to avoid IRS penalties.  It discusses the fact that our system is a "pay as you go" system, meaning it is generally best to pay taxes throughout the year, as stated above.

https://turbotax.intuit.com/tax-tips/irs-letters-and-notices/guide-to-irs-tax-penalties-how-to-avoid...

Good luck!

[KimberW]

There are underpayment penalties imposed unless:

The total of your withholding and timely estimated tax payments didn't equal at least the smaller of:

1. 90% of your current year's tax liability, or

2. 100% of your previous year's tax liability. Your previous year's tax return must cover a 12-month period.

* If your adjusted gross income (AGI) for the previous year was more than $150,000 ($75,000 if your previous year's filing status was married filing separately), substitute 110% for 100% in (2) above.

Also, there is no underpayment penalty if the total tax shown on your current year return minus the amount of tax you paid through withholding is less than $1,000.

Specific answers to your questions:

1. The safe harbor rule you mention applies whether you increase your withholding to 110% of last year's tax OR make estimated payments to get to the same amount
2. The "total tax" from Line 24 of 2023's tax return is the one that matters
3. Underpayment penalties are calculated "per payment" -- essentially for each quarter individually. Withholding is generally treated as having been made throughout the year, regardless of when it is actually withheld. You could also make an estimated payment for the quarter in which you made the Roth conversion.
4. There isn't a specific maximum set by the IRS in the instructions for Form W-4 (line 4c for additional withholding). But your employer or payroll company may have a restriction.

You can make an estimated payment to the IRS at any time by using the Direct Pay option at IRS | Payments or by creating an IRS account and making a payment there. [Having an IRS account is extremely useful and worth the bother of verifying your identity to get it set up.]