Roth Conversion – Paying Federal Taxes and Underpayment Penalty
Can you address underpayment penalty of paying taxes of a Roth Conversion? I understand to max dollars to your Roth account, most promote paying taxes from after- tax accounts (i.e. cash, brokerage accounts…). However the pitfall; you may be subject underpayment penalty if you have not provided and made sufficient 4 quarterly estimated tax payments to the IRS. This is especially problematic if you make the traditional Roth Conversion in last quarter, e.g. December. With this the IRS considers this earn income throughout the year and not the quarter when the conversion was executed. However on the other hand, if you pay your Federal Taxes and have a portion of as “withhold tax” from the converted IRA dollars, then you are not subject to and avoid underpayment penalty, as the IRS considers a withholding as payment was made equally throughout the year. Is my understanding correct?
Permalink Submitted by Alan - IRA critic on Thu, 2025-03-20 10:51
Yes, that is correct.
Note that there would not be an underpayment penalty if you met a “safe harbor” by paying in the lesser of 100/110% of your prior year tax liability or 90% of the current year tax liability in either equal quarterly estimates or withholding at any time.
And if you do not meet the above, you can still reduce the penalty if your income occurred late in the year by using the annualized income installment method on Form 2210AI. But that form is a hassle.
If you withhold from the conversion distribution, less will be converted and you will owe the 10% penalty on the withheld portion if under 59.5. The withholding is also lost from either the TIRA or the Roth IRA and you will owe tax on the amount withheld. But you could replace the amount withheld from your other funds within 60 days of the distribution by a rollover to your Roth IRA even if that date occurred after year end. That would eliminate penalty on the amount withheld and result in a total conversion of the distribution.
Permalink Submitted by Donald Diotallevi on Fri, 2025-03-21 16:02
Thank you for the quick response! FYI, I am over 65 years old, so the 10% penalty would not apply for me. However you made a very interesting comment regarding being able to replace the amount of tax withheld (i.e. less converted dollars) from Roth Conversion distribution, by rollover of funds back to the Roth Account in the amount of the tax withheld. For example, if I made a Roth Conversion of say $200,000 and for simplicity say had Federal tax withheld of $40,000, meaning $160,000 netted actual amount to my Roth Account. I can make a $40,000 rollover (within 60 days) and send money from any non-tax advantage account (e.g. cash saving, money market) to make the total whole of $200,000 to my Roth Account. Did I understand the 60 rollover provisions you stated correctly and their restrictions, and if not, can you please provide further clarification? Is there a IRS form that I would need to send for the rollover to my Roth Account or just need to advise the financial custodian. Can it also be a partial rollover amount, say $20,000 (instead of the full $40,000 withheld), meaning the Roth Conversion of $180,000. As always thank you for your help!
Permalink Submitted by Alan - IRA critic on Fri, 2025-03-21 17:16
That’s correct, you could replace the withheld amount and then report a 200,000 conversion on Form 8606. All you would need to do is make a deposit to the Roth IRA within 60 days of the distribution and advise the custodian that it is a rollover contribution, so they code it correctly.
A partial rollover is allowed also, any portion you wish. You could even roll any or all of the withholding back to your IRA if you changed your mind and only wanted to be taxed for the 160,000 already converted.
Note that there is a one rollover limitation for a 12 month period, so if you rolled over a distribution in the last 12 months, you could not roll any back to a TIRA. However, a conversion is not subject to this one rollover limit, and if you rolled the 40,000 to your Roth IRA it would be a conversion and no problem.