Help – 2020 Interest Penalty from large 3rd Q Roth Conversion
I followed previous interpreted advice from this forum in order to avoid any interest penalty on a large Roth conversion on an annuity. It worked in 2018 and 2019 (4Q conversions), but I received a $150 interest penalty from the IRS from my 2020 return due to the Roth Conversion (Q3).
Specifics: I’m retired with the only income in Q1 and Q2 being bank interest and a very small Social Security amount for my wife (about $5000 combined each quarter). Thus, no estimated taxes in the first two quarters.
In July I converted a $380,000 annuity to a Roth (the insurance company only allowed 100% annuity contract Roth conversions, with about 20% of this being non-taxable due to my basis). I also had a fairly large annual 3rd quarter annuity payment (same % basis, different insurance company, with a 20% withholding, so taxes already covered on that chunk). I paid $20,000 in estimated taxes via EFTPS before the Sep. 15 deadline, specifically to cover the first 50% of this Roth conversion. (Note: I chose July for the conversion because it was preceded the anniversary and index crediting of the annuity and I wanted to convert prior to value appreciation.)
In Q4, I received another fairly large annual annuity payment from another insurance company contract. As above, withholding more than covered taxes on this payment. I made another $20,000 estimated tax payment for the last 50% of the Roth before the Jan. 15 deadline to complete my estimated taxes. Because I filed my taxes on the IRS electronic free file system, I did not send a 1040ES form through this system and the IRS did not apparently know the exact date of the conversion.
It appears that the IRS assumed my large “income” due to the Roth Conversion occurred early in the year, as they waived any fees prior to Jul. 15 (due to Covid hardship for all the U.S.), but charged me interest on about $18,000 from July 15 to Sep. 10 and interest on about an additional $6000 from then to my Jan. 15 payment.
I called them and tried to explain that this was a Q3 Roth conversion, so there was no tax due until Sep. 15 and I paid equal installments (50% each for the final two quarters) and I met the Safe Harbor of >90% of my total 2020 tax bill and >110% of my 2019 total tax bill (from a previous Roth conversion). The final result of this conversation was that they said I had to submit a Form 2210 by mail to explain the timing and estimated tax payments.
My problem is that my interpretation of calculations within this complex form 2210 appears to show I needed to pay nearly 100% of the total tax bill by Sep. 15 (about $45,000 beyond the 3Q withholding for the annuity), and another big chunk by Jan. 15, which combined with withholding amounts, exceeded my calculated total taxes by several thousand dollars. (And in the form instructions, it even mentions you may have to overpay to avoid penalty.)
So when I look at what they’re asking me to send in, it appears they may use that to increase my tax penalty significantly more than their current assumed penalty, based on my interpretation of the form.
So my question really is to find where it is in the tax rules that estimated taxes can be made penalty free in equal payments if started later than the first quarter and also meet Safe Harbor rules. I see no issues with 4 equal payments or 1 4th Q payment, but can’t find where three equal payments for a Q2 conversion or two equal payments for a Q3 conversion are acceptable. Form 2210 seems to front end load the amount significantly.
It might really help if I could see a sample Form 2210 filled out with 0’s in Q1 and Q2, but a large number in Q3 and Q4.
This is important to me both for hoping to avoid this $150 interest penalty, but also because I did another large Roth conversion recently in 2021 and will do another in 2022 and beyond and need to get my current and future estimated tax payments correct. I don’t want to get burned again with penalties when I have the money to cover the taxes, but don’t want to pay earlier than necessary.
Sorry this was so extensive of a forum question, but neither the IRS agent, nor their tax law expert they forwarded me to seemed to grasp my reasoning for two 50% payments and neither could/would they help me verify I was interpreting the 2210 form correctly or not.
Permalink Submitted by David Mertz on Wed, 2021-11-03 23:09
The only permissible options are to treat the total income for the year as received equally throughout the year or to treat the income as taxable in the quarter in which it was actually received. The tax code provides no option to spread income equally over just the last two quarters. As you found, the default treatment would produce heavy underpayment penalties for the first to quarters, so your only real option is to annualize. With annualizing, it appears that your Q3 payment was $20,000 short of what it needed to be to avoid an underpayment for Q3. There is no way to make up the Q3 underpayment with a Q4 estimated tax payment.
Permalink Submitted by Ron Corcoran on Thu, 2021-11-04 15:49
I’m not a pro but pretty sure the 2210 has more to it than previous reply. It annualizes each “period”, calc taxes on each and % due on each, chooses the lesser of, for each. The lesser of the annualized amount, a percent of current year, and pretty sure it also includes 110% of last year’s (if>160k). I too had IRS on my back .. a few years ago (same issue) and ultimately went to my state taxpayer advocate to get to the right POC .. AFTER I had my info all ready, of course .. What a pain, you’d think the 1099 would indicate which quarter so they don’t have to learn this by other means and assume you are guilty because they don’t have the details. I use TurboTax which does most of the 2210, I have to plug in the totals for each period, income & tax paid. I also have a 2210 question and don’t think we’ve found the expert yet
Permalink Submitted by David Mertz on Thu, 2021-11-04 18:49
The IRS does not look at your previous year’s tax return for you, they just go by what is in the tax return that they are processing. Without Form 2210 to provide the previous year’s information, the IRS just applies the default treatment of income received uniformly throughout the year and would not apply the 110% of the previous year’s tax liability safe harbor. Default treatment is certainly not to your advantage in this case. Applying the 110% safe harbor, with withholding and estimated tax payments you need to have covered 3/4 of 110% of your previous year’s tax liability (in other words, 82.5% of your previous year’s tax liability) to avoid having a Q3 underpayment. If a $20,000 Q3 estimated tax payment was sufficient to accomplish that, you should not see any penalties through Q3 calculated on Form 2210.
Permalink Submitted by Ron Corcoran on Thu, 2021-11-04 22:12
Unfortunately you’ll probably have to fill out the annualization portion of that 2210 even tho you are not likely to use. I’m still having trouble wrapping my brain around why the safe harbor percentages are excessive for Q2 & Q3. Eight months is 2/3.
Permalink Submitted by David Mertz on Thu, 2021-11-04 23:04
Yes, you need to annualize income under these circumstances. If you don’t annualize, your income is deemed to have been received uniformly throughout the year, which would result in underpayment for Q1 and Q2.
Section 6654(d)(1)(A) of the tax code dictates that the required annual payment on Form 2210 line 9 be split *equally* among the four tax periods when populating Schedule AI line 24. The number of months in the period is not a factor in determining this split.
Permalink Submitted by Patrick Szary on Fri, 2021-11-05 22:45
The original post indicates he was safe harbor and was not required to make estimated payments. However, I thought safe harbor was based on “withholdings” i.e. via W2 or 1099 voluntary type withholdings. – Form 2210 on line 6 says “Withholding taxes. Don’t include estimated tax payments.- Or even figure 2-A https://www.irs.gov/publications/p505 the first box specifically says to exclude estimated payments… then the rest of the boxes refer to “withholdings”. If he wasn’t safe harbor then he was required to make equal estimated payments. Since he didn’t make equal payments “same amount of estimated tax on each of the four payment due dates.” then he has to use the long method in which the income has to align with the date the tax was paid. Since he spit it over Q3 and Q4 it wasn’t pay as you go.