Do I need to pay estimated taxes for a Roth IRA conversion

Submitted by George Hansen on Tue, 2010-04-06 02:01

I converted my entire Traditional IRA’s to a Roth IRA this year, with about $55,000 in pre-tax dollars from the Traditional IRA’s. This will change my 2010 AGI from $125,000 to $180,000. Do I need to pay estimated taxes before 12/31/2010 in order to avoid any tax penalties (not IRA withdrawl penalties). I did not have any of the IRA dollars withheld for taxes. My AGI for 2009 was $125,000, and I have had a tax refund each year for the last several years.

Thanks.

George



Submitted by mk foss on Tue, 2010-04-06 02:33

There are two ways to avoid penalties for underestimating your tax. One is to pay in 90% of the current year tax on a timely basis by April 15 of the next year. The other is to pay 100/110% of the prior year tax in on a timely basis by April 15 of the next year. You can rely on this second safe harbor rule and avoid paying any taxes on the Roth conversion until you file the return/s showing the conversion.

If you live in a state that has an income tax, you should check those rules as well. Most states follow the two federal exceptions mentioned above. It may reduce your federal tax if you prepay your state tax by the end of the year in which you report the conversion. This doesn’t always work if the Alternative Minimum Tax is a problem for you but it’s worth pursuing.

Submitted by James Rosato on Mon, 2010-05-24 22:16

I don’t understand……”pay on a timely basis by April 15″……I thought “estimated taxes” meant quarterly, not wait until April 15th….

Submitted by Alan Spross on Mon, 2010-05-24 22:29

“Timely” payments can vary depending on the circumstances. While estimated taxes are paid quarterly, if paying by withholding from an income source the withholding is construed to be applied equally throughout the year, even if not actually withheld until December. You can also override the equal quarterly estimates by using the annualized income installment method which provides for estimates to track the taxable income by quarter. You could use that if you plan to convert late in the year, although the 2010 two year deferral throws some unusual wrinkles into the mix.

Estimates can be based on the prior year’s taxes, and while meeting a safe harbor eliminates underpayment penalties, there might still be a large balance due which must be paid by 4/15.

Submitted by Kirk Halveland on Wed, 2010-05-26 22:33

This is very interesting. I just had someone ask me if she needed to pay estimated taxes throughout the year following her Roth conversion to avoid tax penalties.
I guess I don’t understand why paying quarterly taxes to avoid a penalty would even be a consideration? What penalty? ❓

Thanks,

Kirk

Submitted by tomd37 on Wed, 2010-05-26 23:09

Kirk,

Our tax system is on a pay as you go basis and you are expected to pay taxes (through withholding) as you earn the income, not at the end of the tax year. You can incur a penalty for not paying taxes in a timely manner if you end up owing $1,000 or more at the end of the year. The safe haven previously mentioned might keep you out of trouble. Many retirees, drawing RMDs from their taxable IRAs, elect to pay their tax out of the last RMD late in the year. Such a withholding is considered payable throughout the year with no problems incurred.

Tom D.

Submitted by Kirk Halveland on Wed, 2010-05-26 23:45

Thanks Tom!
So you’re saying that a retiree that does a Roth conversion can either pay estimated tax throughout the year or by at least the end of the calendar year, right?
I was under the assumption that they just claimed the conversion amount on their tax return.

Submitted by tomd37 on Thu, 2010-05-27 00:43

You will receive a Form 1099-R showing that amount of the conversion and that will be entered on lines 15a and 15b (IRA distributions) of Form 1040. There could be some complications if you do the conversion early in the year and don’t pay estimated taxes until the end of the year. I would suggest paying your estimated taxes throughout the year (April 15th, June 15th, September 15th, and January 15th) to stay away from any possible penalty. That said, if your 2010 normal withholding will be at least 90% of your 2010 tax bill or if it is 100% of your 2009 tax bill then you are in the safe haven and will not have to make any estimated payments.

Maybe someone will speak up about withholding federal tax from a conversion (for a retiree over age 59.5) and any implication that might have on the amount considered converted. Specifically is the full amount considered converted or the amount less the tax withheld? (Alan S. are you out there and can you help me/us?)

In my previous post I was referring to retirees taking their 2010 RMD (me for example) where my 2010 federal tax withholdings from my military pension and social security benefit will exceed my 2009 tax bill, I will not have anything withheld when I take my RMD late this year. I will opt to pay the tax bill on the RMD when I file my tax return by April 15, 2011. I will not be making any estimated payment during 2010.

Tom D.

Submitted by Alan Spross on Thu, 2010-05-27 02:19

As Tom indicated, ANY withholding is deemed paid equally throughout the year, therefore if you fall behind on your estimates you can make it up with a large withholding election late in the year and erase potential underpayment penalties. That said, withholding from a Roth conversion removes those funds from either the Roth or the TIRA and will also trigger an early withdrawal penalty on the withheld amount if under 59.5 at the time of the distribution. Only the amount actually going into the Roth is considered converted, the withheld amount is just distributed. If you are extremely “IRA heavy” and cash poor and over 59.5, the conversion withholding could work out fine, otherwise it is probably not a good idea.

And in 2010, there are the added complexities of the choice for the year the conversion will be included in taxable income. But since the usual safe harbor for a year with increased income is the prior year tax liability, if you pay estimates or withholdings based on 2009 tax liability, even if you opt out of the two year deferral, you will owe the taxes for 2010, but will NOT incur an underpayment penalty because you will have met one of the safe harbors.

For payments subject to withholding, you can frequently make a one time December election for increased withholding, and then return to the usual amount in January. This works with many pension administrators, but I would not recommend this with SS withholding as the SSA is probably prone to messing up those changes. Once you get the amount you want withheld from SS payments, probably best to leave that alone and work with other sources for any changes.

Submitted by tomd37 on Thu, 2010-05-27 02:27

Thanks Alan. The matter of the actual conversion amount when over 59.5 is what I had some doubt about. I suspect same, but was looking for your confirmation. I was certain about the 10% penalty under 59.5, but assumed the poster was over that age. Again, thanks.

Tom D.

Submitted by Kirk Halveland on Thu, 2010-05-27 22:00

Tom and Allen, thanks for the updates.
I just want to be clear. If we pay 90% of the prior years tax liability at quarterly intervals in the current year, we would most likely avoid any penalties.
So we convert to Roth in 2010, we take the deferral option of conversion taxes into years 2011 and 2012. We would make quarterly estimated tax payments based on 2010 tax liability. I hope I finally have this; please let me know. Your knowledge is appreciated!

Kirk

Submitted by mk foss on Thu, 2010-05-27 22:26

Not exactly correct. You avoid estimated taxes by paying 90% of the current year’s tax or 100/110% of the prior year’s tax. If 2009 tax was $10,000 – you’d have to pay in (through withholding or estimates) – $10,000 on a quarterly basis for 2010 with the last payment due 1/15/11. If your actual 2010 tax was $30,000 because you had a Roth conversion and elected to pay the tax in 2010 – the IRS would impose no penalties for underestimating the tax. If you did the Roth conversion in 2010 but were paying the tax in 2011 and 2012 each on half of the conversion amount – you need only pay 90% of the expected 2010 tax in on a timely basis (assuming 2010 tax is less than the tax for 2009).

If someone had a very low tax for 2009 because no RMDs were required – basing 2010 estimates on 2009 will minimize the quarterly payments and push tax payments to April 15, 2011. Seeing the bill next spring for a conversion may help decide which years to report it and whether a recharacterization looks good.

Submitted by James Casey on Fri, 2022-04-22 21:11

If we did a Roth conversion in 4th quarter of 2021 and paid the estimated taxes for the conversion in the same quarter (one payment using funds from our current salaries), will we owe a penalty when we file our taxes?   In other words, would we be penalized for not making quarterly payments throughout the year?  We are due a small refund from the IRS.  Thank you for your assistance. 

Submitted by Alan - IRA critic on Fri, 2022-04-22 22:26

If the refund you mentioned was mostly due to the large estimate to cover the conversion, you could still be penalized for the first 3 quarters because the IRS will assume you converted an equal amount per quarter, then paid the estimate too late. However, there is a rather nasty form you can file (Form 2210 AI) that documents the quarter you did the conversion, and breaks your taxable income into quarters. That may take care of your penalty, depending on the actual numbers. But completing the form  will take time, and if you have already filed for 2021, you will probably have to file an amended return to include the form.

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