Roth Conversion and Estimated Tax Payments
Hello,
I understand that the IRS considers taxes to be due when income is earned. I’m planning on making a large (by my standards) Roth conversion of $250k-$300k in Q1 2022, but I’m having trouble determining if I need to pay a large estimated tax in Q1 to cover the liability, or if I can make smaller but equal estimated tax payments for each quarter. In either case, the tax amount due from other sources of income would be included in the estimated quarterly tax payments.
I believe the 110% safe harbor rule is one way to get around a potential underpayment penalty, but I had a very large one-time capital gain at the end of 2021 which I believe would force me to make unreasonably large estimated tax payments in 2022 to meet the safe harbor requirement.
I’d rather convert the full amount to my Roth in one shot in Q1 2022 so it has more time to appreciate. The other option is to make four Roth conversions, one each quarter, and pay equal amounts of estimated tax each quarter. I’d like to avoid having to use the ‘annualized income installment method’ to avoid an underpayment penalty if at all possible as it’s a huge pain.
Any thoughts on whether I can convert the full amount in Q1, or is it better to do four separate conversions?
Permalink Submitted by Alan - IRA critic on Thu, 2022-01-06 02:16
If you are using your 2021 tax liability as your safe harbor to avoid an underpayment penalty, you only need to make your quarterly estimates of 25% (27.5% for higher incomes) of that amount by the regular due date for quarterly estimates. It does not matter that your conversion will be done in the first quarter. You could instead use a safe harbor of 90% of your 2022 tax liability, but you won’t know that early in 2022. The lowest safe harbor will of course depend on which year ends up with the lower tax liability. Cap gains are taxed at a lower rate than conversion income, so your safe harbor will not necessarily depend on taxable income, rather the tax liability.
The 2210 AI is only helpful if you backload the conversions, and it does not appear that you will be doing that.
It’s a crap shoot whether early year conversion will turn out better than spreading out the dates or not, as the market timing issues which no one can easily predict would likely trump any underpayment penalty. You could also mix and match withholding with the estimates, and withholding is treated as being done equally throughout the year regardless of when you actually have the withholding paid.
Permalink Submitted by Mark Gaydos on Thu, 2022-01-06 14:19
Thanks very much for your comments. Somehow I missed the fact that the 90% rule applies to 2022 taxes, and not the previous year’s (2021) taxes. I can reasonably accurately predict my taxes for 2022, and perhaps pay a bit extra each quarter just to be safe. This also gives me the option to make a predetermined dollar amount of Roth conversions however I decide to – ranging from a single conversion to many. Obviously no one can predict the stock market, but if during any particular quarter the market has made a correction, I can do a conversion at that time in order to benefit more from a rebound. Of course timing the market is impossible, and a falling market could continue to fall, but at least it’s a plan (of sorts).