Recharacterization and income tax
I have converted close to 1 Mil to Roth IRA in 2010. I would like to hold off making this final and keep my option to re-characterize open for as long as possible. I also do not want to generate tax penalties for underpayment of tax.
Do I need to pay what I owe to the IRS by April 18 and also request an automatic 6 month extension to file, to accomplish this?
Thanks for any help. P.S. Love this discussion board.
Permalink Submitted by Alan Spross on Sat, 2011-03-19 21:29
To keep your recharacterization option open until 10/17/2011, you must either file your return or an extension by 4/18. Either way, to avoid penalties you need to pay what you think you will owe for 2010. That obviously depends considerably on whether you plan to defer the conversion income or report the entire conversion on your 2010 return. If you plan to defer the conversion income, your payment due on 4/18 can be calculated without considering the conversion.
If underpayment penalties are your concern, you would probably use the prior year safe harbor method to determine your quarterly estimates. If you met your safe harbor for 2010 based on 2009 there will be no penalty. But if you retain the conversion and report the income in 2011 and 2012, you need to start paying your 2011 quarterly estimates by 4/18 based on your 2010 estimated tax liability. Therefore, you can reduce the number of possibilities if you know IF you keep the conversion, which years you will report it.
Permalink Submitted by Peter Lingane on Sat, 2011-03-19 23:39
Alan’s strategy of making your 2011 estimates based on you 2010 tax liability is a good one if you are planning to defer the conversion income to 2011/12.
If you plan to report the conversion income in 2010, think long and hard before listing a tax liability on the extension which is substantially less than your potential liability. The federal extension form asks for the anticipated tax liability and there are court cases where the IRS has claimed an extension to be invalid – and the judge agreed – because the tax liability stated on the extension did not reflect all of the facts and circumstances. If the extension is invalid, you loose the chance to recharacterize and you will be assessed a 25% failure to file penalty.
While it is important to be realistic when completing the extension form, the consequences are not dire if you pay less than the tax liability shown on the extension. You will pay about 5% in penalties and interest on the difference between what you pay by April and the tax liability shown on the return that you file in October. You have to decide whether to risk 5% of the underpayment vis-a-vis your chances of earning 5% or more (possibly 8% or more before tax) on the underpayment over the next six months vis-a-vis the underpayment being small because you recharacterize or defer the conversion income to 2011/12.