Your Questions on Paying Estimated Taxes, Answered

Federal estimates | Taxes | IRS | Penalty | November 6, 2024

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Q: In December, I determined I had enough cash available to pay taxes owed on a lump sum, one-time Roth conversion of $200,000 and sent a check for taxes using the estimated-payment form. I received a large refund, so I overpaid, but I also received an underpayment penalty. How do I avoid an underpayment penalty? At the end of the year, I convert to Roth but only if I have the available cash to send a check for the taxes.—a reader in Somerville, N.J.

A: You aren’t alone: Other WSJ readers have experienced this problem.

Here is how it happens, according to an Internal Revenue Service spokesman. Say that a taxpayer has a surge of income in the fourth quarter that doesn’t have withholding. If he makes a tax payment covering this income in the same quarter, the IRS’s computers won’t match them. Instead, the system assumes the income was earned evenly throughout the year. Then it assesses an interest-based penalty because it thinks that some of that tax was due earlier and that estimated payments should have been made in earlier periods.

To avoid the assessment of an underpayment penalty, the taxpayer should submit Form 2210. Be sure to complete the part of it called Schedule AI, which will match the income and the tax payment. If the tax was sufficient, there shouldn’t be an underpayment penalty.

Filers who do their own returns should check their software. A spokeswoman for Intuit says TurboTax supports both Form 2210 and Schedule AI. At H&R Block, a spokeswoman says its online platform can handle Form 2210 but not Schedule AI, although an H&R Block tax pro could help with it virtually or in person.

The IRS spokesman adds that the taxpayer in question can ask for a refund of an incorrect penalty. To do this, filers should send in the notice of the penalty with a correct Form 2210 (including Schedule AI) and request an adjustment. Given constraints on IRS resources, resolution could take quite a while.

Q: I am retired and my income has dropped to the point that I am considering doing a Roth conversion. I know when money is moved from my traditional IRA to a Roth IRA, I pay taxes on what was withdrawn. Are these taxes automatically withheld similar to wages on a W2 or do I need to file a quarterly tax payment to avoid under-withholding penalty?—a reader in Rollinsford, N.H.

A: Tax isn’t automatically withheld on traditional IRA assets converted to a Roth IRA, although you can ask the IRA sponsor to withhold it. (In that case, the withholding would be reported on your 1099-R form.) However, Roth IRA specialists advise paying the tax with “outside” funds rather than with converted funds if at all possible. Doing so leaves more in the Roth account to grow tax-free.

Savers who do pay the tax on a Roth conversion will often need to pay quarterly estimated taxes in the period when the conversion is made. It’s also possible—and often easier—to pay the tax by adjusting withholding elsewhere.

Q: I converted $60,000 of my self-directed IRA investment(s) to Roth in November of 2023. I increased the amount of our 9/15/23 and 1/15/24 estimated payments. I anticipate that the total estimated payments will be sufficient to cover the additional tax liability for 2023 after the conversion. Are my estimated payments required to be equal even though I didn’t convert these funds until November?—a reader in San Jose, Calif.

A: No. The idea with estimated taxes is to make the tax payment in the same period as the income. So the taxes could vary a lot from period to period if income varies.

In general, taxpayers who are self-employed or receive income from nonemployment sources like pensions, IRA withdrawals, dividends or interest often owe quarterly estimated tax payments on this income. By contrast, filers who receive a regular salary typically have tax payments withheld from their paychecks. Our Tax Guide overview addressed the basics of both; for more information, see IRS Publication 505.

Q: Have any changes been made to the withholdings from RMDs (required minimum distributions) being treated as having been ratably made over four quarters, which benefits those taking a RMD late in the year. Would this rule also apply to withholdings from a January RMD or is there an election available to the taxpayer to treat those withholdings as a first-quarter estimated payment?—a reader in Chattanooga, Tenn.

A: No, no changes—but this question touches on an important benefit many filers are unaware of.

The benefit is that taxpayers don’t have to file quarterly estimated tax payments if they can adjust their withholding on other income enough. This move comes with a bonus: Withholding is assumed to be even throughout the year whenever the actual payment date is.

For example, say an investor has a capital gain of $20,000 in the first quarter. He might owe an underpayment penalty if he doesn’t pay estimated taxes due on it in that quarter. But if this investor raises the withholding on a paycheck or IRA payout enough to cover the tax—even in December—there is no estimated-tax penalty.

According to Ed Zollars, a Phoenix-based certified public accountant, this rule applies for withholding on paychecks, traditional IRA withdrawals (including RMDs), Social Security payments and pension payments.

It might be hard for pension providers or the Social Security Administration to move quickly on end-of-year withholding adjustments, so Zollars suggests looking elsewhere.

“It’s easy to change withholding on IRA withdrawals or wages paid by a small, closely held firm,” he says.

 Credit goes to Laura Saunders, published in the Wall Street Journal on February 12, 2024
 
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This Week’s Author, Belinda Stickle