Tax Underpayment Penalty

[Turgeon]

I executed a Roth Conversion in November which resulted in a large amount of taxable income.  There were no taxes withheld when the Roth Conversion was made.  I made an estimated tax payment on 1/15/2024 in order to make up for the income from the Roth Conversion.  A tax underpayment of several hundred dollars is assessed despite there being more than enough tax withheld and paid with the estimated payment.

Is there a simpler method to exempt the tax underpayment penalty besides performing an annualization of my adjusted gross income?  Since the Roth Conversion was done at the end of the year, my estimated payment on 1/15/2024 was received by the IRS in plenty of time.  I would think that this is a pretty common scenario.  Determining when interest, dividends, and stock sales were made is a lot of work to perform to calculate annualized adjusted gross income for the first three quarters of the year!

[DaveF1006]

No. Unfortunately, there is not an exception to the estimated tax penalty other than calculating annualized gross income for the first three quarters of the year. 

The law does allows the IRS to waive the penalty if:

1. You didn't make a required payment because of a casualty event, disaster, or other unusual circumstance and it would be inequitable to impose the penalty, or
2. You retired (after reaching age 62) or became disabled during the tax year or in the preceding tax year for which you should have made estimated payments, and the underpayment was due to reasonable cause and not willful neglect.

Also, you may waive the penalty if you go to:

1. Federal
2. Other Tax Situations
3. Additional Tax Payments
4. Underpayment Penalties

As you scroll through the screens, you will reach a screen that looks like this screenshot. If you can answer all three questions, you may be able to waive the penalty.

Penalty for Underpayment of Taxes

[dmertz]

Is there a simpler method than annualizing?  If you do not meet any of the safe-harbors, no.  The US tax system is generally pay as you go, but to simplify things for the majority of individuals the IRS provides a default method that treats your income, deductions, credits and tax withholding as received uniformly throughout the year.  Note, however, that estimated tax payments are never treated as received uniformly throughout the year.  They are treated as paid when actually paid.  Of course for those who receive a large amount of taxable income late in the year the default method doesn't work and it must be abandoned in favor of annualizing income.

What you could have done to avoid needing to annualize income would have been to have taxes withheld from the Roth conversion equal to the estimated tax payment that you would otherwise have to send, then complete the Roth conversion of the withheld amount indirectly by substituting other funds.  This avoids the need to annualize because tax withholding is treated by default as having been withheld uniformly throughout the year.  Such a method can also be used to manufacture tax withholding if you would have underpayment for earlier quarters even without the Roth conversion.  The alternative is to anticipate your Roth conversion and increase your tax withholding from other sources or to pay your estimated taxes evenly over the four tax quarters.