Author Topic: Help with Roth Conversion Taxes  (Read 908 times)

mattydt20

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Help with Roth Conversion Taxes
« on: April 11, 2020, 01:38:40 PM »
I went back to graduate school this year, so my wife and I planned to do a Roth Conversion while our income is low. With the market crashing I converted 50k from traditional IRA into Roth. The additional 50k should keep us in the 12% tax bracket for the year (my wife will make a max of $50k), considering the $24,000 standard deduction.

I assumed the taxes for this transaction could be paid when we do our taxes next January. It sounds like I should pay it now or face a potential penalty. Can anyone provide advice regarding how I should go about doing this?

Thanks in advance!

MDM

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Re: Help with Roth Conversion Taxes
« Reply #1 on: April 11, 2020, 01:49:29 PM »
See the first few lines in form 2210.  Pretend you are filling this out next year (so in all the instructions, add 1 to the year).

Combined with your predicted form 1040 for 2020 (filed in 2021), what do you get?

terran

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Re: Help with Roth Conversion Taxes
« Reply #2 on: April 11, 2020, 04:27:48 PM »
There are a number of safe harbors under which you won't owe a penalty for tax underpayment. See "Penalty for Underpayment of Estimated Tax" at https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes -- don't worry that it talks about small businesses, the rules are the same. If you pay the tax from your wife's withholding it will be assumed that it was timed appropriately no matter when in the year the withholding happens, unlike estimated taxes which can incur a penalty even if you otherwise meet a safe harbor.

startbyservingothers

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Re: Help with Roth Conversion Taxes
« Reply #3 on: April 12, 2020, 01:24:41 PM »
$5-$6k  is a pretty substantial underpayment.  Did you get a refund this year?  I don't care much for calculating the penalties myself, but I notice some trends:

1.  Penalties are larger/ more likely to happen if you also owed, or owed more last year.
2.  Penalties are more likely when you owe larger amounts.
3.  Many states charge penalties on much smaller amounts than the fed.

Personally I wouldn't risk waiting until tax filing for a few weeks 0% APR money.   Estimated payments made by Jan 15 can be applied to 2020 4th quarter.
 
Of course timing the market is a personal preference, but over the next few months I'm getting cash on hand to increase my money in the market.  I would focus on paying some money toward the IRS bill in Dec or Jan.

DaMa

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Re: Help with Roth Conversion Taxes
« Reply #4 on: April 12, 2020, 06:16:38 PM »
I moved 45k in December from tIRA to Roth, and paid estimated taxes in December.  I incurred underpayment penalties.  (My thought was that the estimated tax was paid at the time I took the distribution.  Nope.)

I got the penalty waived on federal, but there was no waiver for state taxes.  I would increase the withholding on yours or wife's payroll to match the expected tax payment (or at least 90% of it) if you can.  If not, make equal estimated tax payments this year each quarter.  Those dates are changed for 2020 due to COVID-19.

phildonnia

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Re: Help with Roth Conversion Taxes
« Reply #5 on: April 13, 2020, 09:32:09 AM »
You can use the "safe harbor" method for estimating your taxes.  Basically, you're safe if you pay at least as much* as your prior year tax liability (2019 Form 1040, Line 14) in withholding and estimated taxes.  Divide this by four, and, make sure that you've paid at least this amount in withholding and estimated taxes each quarter.

* Unless you're "high-income": then add another 10%. 

Or as MDM says, fill out page 1 of form 2210 (and use "2020" wherever it says "2019").  If you have no idea what to put on lines 1-4, put "one billion dollars", and it will get ignored by the time you reach line 9.  Line 8 is where you put your prior-year tax liability.
« Last Edit: April 13, 2020, 09:37:20 AM by phildonnia »

MDM

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Re: Help with Roth Conversion Taxes
« Reply #6 on: April 13, 2020, 09:49:22 AM »
You can use the "safe harbor" method for estimating your taxes.  Basically, you're safe if you pay at least as much* as your prior year tax liability (2019 Form 1040, Line 14) in withholding and estimated taxes.  Divide this by four, and, make sure that you've paid at least this amount in withholding and estimated taxes each quarter.

* Unless you're "high-income": then add another 10%. 

Or as MDM says, fill out page 1 of form 2210 (and use "2020" wherever it says "2019").  If you have no idea what to put on lines 1-4, put "one billion dollars", and it will get ignored by the time you reach line 9.  Line 8 is where you put your prior-year tax liability.
There are three safe harbors, and reaching any of them shelters one from underpayment penalties.

MustacheAndaHalf

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Re: Help with Roth Conversion Taxes
« Reply #7 on: April 14, 2020, 06:59:59 AM »
I tend to forget about taxes in July and October, so I've learned to pay estimated taxes in April (of the year before) and Dec/Jan (when my information is more accurate).  I suspect my 12 month in advance payment has the biggest impact - lowers the penalty the most.

This looks like an unpredictable year, so I'll probably pay 2/3rds of my estimated taxes now, for next year.  You can play with tax software to see how the estimated penalty changes based on when you make the payment.

In my experience, the safe harbor provision tends to work well when you're income is going up, but not be useful when it drops suddenly.  So I just go with 2 estimated payments a year - not according to how the IRS wants it done, but certainly lowers the penalty enough to stop caring.

Also search for "IRS direct pay" (don't trust IRS links from strangers!) to see how you can schedule an IRS withdrawal online, from your bank account.  Once it's setup, it's fairly easy to do.  I mean, except for getting the money together and watching it go...