Annualized income estimated taxes: capital gains and capital loss carryover

[terran]

It looks like it's going to make sense for us to use the annualized method for our estimated tax payments this year (2024) due to planned Roth conversions late in the year. We have a small capital loss carryover from previous years which will likely be either matched by capital gains or the capital gains will exceed the loss, but not in the earlier quarter(s).

I haven't been able to find any guidance on how to account for the capital loss carryover when calculating annualized income for each quarter. Anyone have any thoughts?

• Do I claim a capital loss up to $3000 against annualized income in each quarter until it's erased by gains?
• Do I let it offset gains in any quarter, but not use it as a deduction against ordinary income since I don't expect there to be any remaining losses by the end of the year?
• Do I spread the carryover loss across quarters in some way regardless of when offsetting gains happen and if so, how should I distribute it?
• Some other method?

Thanks!

[secondcor521]

Since you expect your capital gains this year to absorb the carryforward loss, and because it is more conservative to do it this way, I would use the carryforward loss against any actual YTD capital gains as you calculate your 1040-ES payments each accounting period, but not to offset any ordinary income.

Then if you need to complete Form 2210 Schedule AI in the spring, if it turns out that any of the carryforward actually offsets ordinary income - which you should know by that time - I would apply it first against capital gains in any quarter, and then against ordinary income up to the actual offset amount in each accounting period.

So if you have $1000 carryforward and have $400 in capital gains in the first and third accounting periods, I would use $400 of the carryforward when calculating the first and third 1040-ES payments.  Then, once 2024 closes out and you realize that an extra $200 would offset ordinary income, I would on Schedule AI use $400 of the carryforward in the first period, then $200 against ordinary income in the second period (assuming you had $200 of ordinary income in the second period), then $400 in the third period.

This approach doesn't get you the most optimal second 1040-ES payment, but the difference is likely to be minimal.  It also doesn't rely on capital gains in a later period which may or may not show up.

[terran]

I think that makes sense.

I'm not quite sure I follow why the $200 excess carryover should be applied to the second period rather that any other period. Maybe I'd just apply it to the last period since that's when I'd know for certain what it would be and since I can't really be faulted for making the final payment smaller rather than an earlier payment. Like you say it probably won't make much difference. I also think I'd have to be careful of the multipliers that annualize AGI in earlier periods since that could change a $200 annual loss into an $800, $500, or $300 annual loss if claimed in full in an earlier period.

Thanks for your help!

[secondcor521]

I think that makes sense.

I'm not quite sure I follow why the $200 excess carryover should be applied to the second period rather that any other period. Maybe I'd just apply it to the last period since that's when I'd know for certain what it would be and since I can't really be faulted for making the final payment smaller rather than an earlier payment. Like you say it probably won't make much difference. I also think I'd have to be careful of the multipliers that annualize AGI in earlier periods since that could change a $200 annual loss into an $800, $500, or $300 annual loss if claimed in full in an earlier period.

Thanks for your help!

The thinking would just be to apply it to the earliest possible period.  At that point (next spring) you know the $200 will offset ordinary income, and if you have ordinary income in the second period, it would seem reasonable to apply it at that point...in theory although not in practice, it would be possible for you to not have any ordinary income in the fourth period to apply it to.

I think, but am not certain, that applying it to the earliest period would minimize any underpayment penalty on Schedule AI, which would be a practical reason to do it that way.

[terran]

Couldn't you then apply the excess to the first period? That is, does it matter whether there are capital gains in a period as long as the future capital gains in later periods are covered by the carryover? I think I'd still have the divide the excess by the multiplier for that period to avoid overcounting the capital loss deduction in the first three periods.

I think for calculating my estimated payments I still won't count any loss deduction until the final payment since I won't know for sure what any excess loss might be until the end of the year.

[secondcor521]

Couldn't you then apply the excess to the first period? That is, does it matter whether there are capital gains in a period as long as the future capital gains in later periods are covered by the carryover? I think I'd still have the divide the excess by the multiplier for that period to avoid overcounting the capital loss deduction in the first three periods.

I think for calculating my estimated payments I still won't count any loss deduction until the final payment since I won't know for sure what any excess loss might be until the end of the year.

Now that I think about it, yes, I think you could.  As long as you had enough ordinary income in the first period, of course, but that's pretty likely.

And yes, I think you do need to reserve enough carryforward for any later periods' capital gains, because that's what they should offset "first" over the whole tax year.

I didn't look at it too closely, but I think the way the ES and AI stuff works is, you either are doing things on a full year basis or YTD basis respectively, and the multiplier stuff happens later.  So I don't think you need to adjust in the way it sounds like you think you do.  But I'm not confident enough in that assessment to recommend not adjusting.  You'll probably figure that part out when going through the worksheets.  Also probably won't matter too much assuming "typical" carryforward and income amounts.

[terran]

On Form 2210 Schedule AI you start line 1 with AGI from January 1st through the end of the period you're calculating, so that's what capital gains/losses would be used to calculate, and then you use a multiplier (4 for income through 3/31, 2.4 for income through 5/31, 2.4 for income through 8/31 and 1 for income through 12/31) to annualize that income. That's why I think if you used the full capital loss deduction in one of the earlier periods to calculate AGI you'd end up overstating the deduction. You calculate the tax as if you repeated the same income pattern to date for the whole year, then un-annualize the tax due to arrive at that quarters payment.

The multipliers also mean you'd overstate any one time income early in the year, so it seems like schedule AI is really best used when you have extra income late in the year, if it can be helped.

[secondcor521]

Sure.  But if you have $400 in CG in period 1 and apply a $400 carryforward loss, you would either annualize both (as Schedule AI would have you do, and Form 1040-ES probably also does) by using the multipliers or neither.  I thought you were implying earlier that you would annualize one but not the other, which would not make sense to me.

And yes, Schedule AI is AFAIK optional and would only be used in cases where it reduces the penalty, i.e., in cases where there is more income later in the year and the estimated payments were similarly weighted towards the back end.  If that's not the case, then I think one hits or can use one of the earlier offramps in the whole ES/AI thing.

Again, I'm just familiar enough to be dangerous with this stuff.  I have never had to do it myself, although 2024 may be my first year.  I don't have a carryforward to deal with though.

[terran]

Yeah, if the gain/loss nets to $0 then the annualizing doesn't really matter. I was talking about the possibility that their's an excess less. In that case, using the $200 loss from earlier, if that was used in period one it would be multiplied by 4 for a $800 annualized loss, 2.4 in period two for a $480 loss or 1.5 in period three for a $300 loss.

I guess that's the same thing that happens with any income or schedule 1 adjustments to income that can go into AGI, so I'm not really sure you're supposed to handle lumpy deductions (like if you contributed to a deductible IRA early in the year). Maybe they just figure you get close enough and they don't worry about it too much.

I think the only real off ramps before schedule AI are hitting a safe harbor (which means paying estimated tax in 4 equal installments or paying only through withholding) or treating income as being earned equally throughout the year which requires the same 4 equal installments or paying more estimated taxes early to avoid a penalty.

I could be missing something, but I'm pretty sure if you want to pay late in the year and avoid a penalty then you're pretty much stuck filling out schedule AI. It doesn't seem too bad though, it's just that starting with AGI is a little bit of a black box for things that are more questionable in terms of when they happened. It's more obvious for income since you either received it or you didn't receive it. It seems like a little more of a gray are for other things and the capital loss carryover most of all since it didn't actually happen in any of the periods on the form.

I'll probably just be conservative by erring on the side of paying more tax early. It'll still result in much more of the tax being paid in the final payment than if I went with 4 equal payments.

[secondcor521]

I see what you're saying.

At this point I think I should point out something that I think I know:  Form 2210 Schedule AI is not for figuring out what your estimated quarterlies should have been; it's for minimizing or eliminating the underpayment penalty if you need to.

To figure your estimated quarterlies with uneven income, I think you should look to IRS Pub 505 and in particular this section:  https://www.irs.gov/publications/p505#en_US_2025_publink1000194595.  I would expect the math and procedures there (such as Worksheet 2-7) to more or less parallel Form 2210 Schedule AI.  But maybe there are some helpful nuggets there if you review it.

More or less, it seems like you recalculate your YTD tax situation every accounting period, so if you somehow end up under one period, you should catch up the next.

I am not sure how likely it is for the IRS to assess an underpayment penalty if the total of withholding plus back-loaded ES payments results in a balance owing of under $1K.  I know Form 2210 line 6 says to exclude ES payments; I'm just wondering how much the IRS enforces that particular aspect of the rules.  Perhaps @MDM knows.

[MDM]

I am not sure how likely it is for the IRS to assess an underpayment penalty if the total of withholding plus back-loaded ES payments results in a balance owing of under $1K.  I know Form 2210 line 6 says to exclude ES payments; I'm just wondering how much the IRS enforces that particular aspect of the rules.  Perhaps @MDM knows.

I think the enforcement of that calculation is strict, because it is easy for the IRS computers to check it.

As for the question in the OP, the 2023 Estimated Tax. Part I, Line 4 worksheet says, "Enter your net capital gain expected for 2023."  That could have changed as you went through the year, so whatever you plausibly thought it would be at each "quarterly" checkpoint would go there and thus affect the tax calculation for that period.

[terran]

At this point I think I should point out something that I think I know:  Form 2210 Schedule AI is not for figuring out what your estimated quarterlies should have been; it's for minimizing or eliminating the underpayment penalty if you need to.

To figure your estimated quarterlies with uneven income, I think you should look to IRS Pub 505 and in particular this section:  https://www.irs.gov/publications/p505#en_US_2025_publink1000194595.  I would expect the math and procedures there (such as Worksheet 2-7) to more or less parallel Form 2210 Schedule AI.  But maybe there are some helpful nuggets there if you review it.

More or less, it seems like you recalculate your YTD tax situation every accounting period, so if you somehow end up under one period, you should catch up the next.

Yeah, it's pretty much parallel to form 2210. For example, Schedule AI becomes Worksheet 2-7.

As for the question in the OP, the 2023 Estimated Tax. Part I, Line 4 worksheet says, "Enter your net capital gain expected for 2023."  That could have changed as you went through the year, so whatever you plausibly thought it would be at each "quarterly" checkpoint would go there and thus affect the tax calculation for that period.

Interesting. Given that all of these forms start with "enter your AGI" or "enter your estimated income" it seems like a little more like an art than a science.