Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

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Railfan
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Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by Railfan » Wed Sep 13, 2017 7:48 pm

I will be converting some or all of my traditional IRA to my Roth over the next couple of years. The conversions will likely be done multiple times a year on an irregular basis, and perhaps in differing amounts, and so it would be difficult to know in advance how much to pay in regular quarterly estimated tax payments.

Since my income apart from the conversions is extremely regular and predictable, I will pretty much know what tax bracket the individual conversion amounts will push me into. So each time I do a conversion, my plan is to use IRS Direct Pay to make an estimated tax payment within a few days based on the tax bracket that the particular conversion amount puts me in. In essence, this would be my own version of withholding, a pay-as-you-go system.

My question is this: Is this an acceptable (to the IRS) way of paying my estimated tax? I have used Direct Pay a few times in the past but not at the level and frequency I plan on for the next few years. I find it an easy and hassle-free way to make these payments. Are there any limits as to when and how many estimated payments I make throughout the year as long as they follow directly (within a few days) of the conversion?

I know there might be better ways of doing it that would possibly keep more dollars in my savings account until the last possible moment before the taxes are due, but I prefer the hassle-and-worry-free pay now and be done with it method.

Thanks for any input.

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FIREchief
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by FIREchief » Wed Sep 13, 2017 10:39 pm

Why not do the entire annual conversion in January and then pay the additional taxes in four equal estimated tax installments in accordance with the IRS quarterly deadlines?
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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FiveK
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by FiveK » Wed Sep 13, 2017 11:03 pm

Railfan wrote:
Wed Sep 13, 2017 7:48 pm
My question is this: Is this an acceptable (to the IRS) way of paying my estimated tax?
Yes. It may require you to use the more complex parts of Form 2210 to avoid penalties when you file next year, but the IRS does allow one to use this secure service to pay ... estimated taxes.

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Railfan
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by Railfan » Wed Sep 13, 2017 11:19 pm

FiveK wrote:
It may require you to use the more complex parts of Form 2210 to avoid penalties
Why would I be liable for penalties if I pay the tax within days of the conversion? Complex forms are what I was hoping to avoid. :annoyed

kaneohe
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by kaneohe » Wed Sep 13, 2017 11:27 pm

Railfan wrote:
Wed Sep 13, 2017 11:19 pm
FiveK wrote:
It may require you to use the more complex parts of Form 2210 to avoid penalties
Why would I be liable for penalties if I pay the tax within days of the conversion? Complex forms are what I was hoping to avoid. :annoyed
IRS will know when you paid but it won't know when your income (conversions) were done until you tell them on SchAI of F2210. You are right
to want to avoid having to fill out that form.......kind of like doing 4 tax returns at once. You won't have any penalties if you fill out that form but if you don't, you might. In the absence of that form, IRS assumes your income is distributed evenly throughout the year so if your estimated payments are less than that, they assume that one or more payments were insufficient/late.

Why do the conversions have to be seemingly unplanned and last minute.........why can't they be known at the beginning of the year for that one year so you can pay in equal installments during the year.
Last edited by kaneohe on Wed Sep 13, 2017 11:51 pm, edited 1 time in total.

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FiveK
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by FiveK » Wed Sep 13, 2017 11:42 pm

Railfan wrote:
Wed Sep 13, 2017 11:19 pm
FiveK wrote:
It may require you to use the more complex parts of Form 2210 to avoid penalties
Why would I be liable for penalties if I pay the tax within days of the conversion? Complex forms are what I was hoping to avoid. :annoyed
You wouldn't be liable, but it might require more documentation to prove it.

The extreme case is having a single large income and corresponding estimated tax payment at the very end of the year. You would likely want to check Box C in Part II of Form 2210.

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Railfan
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by Railfan » Thu Sep 14, 2017 8:14 am

FIREchief asked:
Why not do the entire annual conversion in January and then pay the additional taxes in four equal estimated tax installments in accordance with the IRS quarterly deadlines?
To go into just a little more detail, I don't really mean for it to sound like it's all unplanned and haphazard: what I'm thinking is to use share-price averaging to move the money out of the traditional IRA, much like dollar-cost averaging in. If the market stays relatively stable, I plan to convert a defined dollar amount each quarter that will keep me within my pre-planned tax bracket range. On the other hand, it seems pretty frothy to me, and if it took a tumble I might temporarily bite the bullet on the tax bracket limit to be able to convert a relatively larger number of shares out of the traditional for the same dollar while the price is low(er). I'm not trying to time the market for a fall but just keeping my options open.

I also want the least amount of hassle in the process - my taxes are currently pretty predictable and simple to do and I thought perhaps by using a pay-as-you-go type of system everything would be kept up-to-date and I'd end up just right with the taxman at the end of the year no matter how I handled the conversions.

The Wizard
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by The Wizard » Thu Sep 14, 2017 8:21 am

Modify your withholding for a pay period or two instead.
I could do that online with my former employer and specify an additional $1000, which would cover a $4000 Roth conversion in the 25% bracket.

But most people feel it unwise to Roth convert on top.of full time employment.
So maybe your regular Income is from 1099-Rs like me.
Nonetheless, adjust the withholding to cover the additional tax and no additional form will be needed...
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Railfan
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by Railfan » Thu Sep 14, 2017 8:38 am

The Wizard said:
Modify your withholding for a pay period or two instead.
I'm retired, and taking the amount of withholding I'd need wouldn't be practical. The big problem is I should have started doing the conversions the minute I retired. Now I'm looking at a fairly substantial RMD (I know, I know, cry me a river) in a couple of years and trying to move as much as I can without getting into the top tax brackets.

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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by The Wizard » Thu Sep 14, 2017 8:47 am

OK, so use direct pay, but pay more tax in the first three to six months of the year than the last six months.

Where you're likely to get into trouble is doing a large Roth conversion on December 15th and a single direct pay transaction a few days later without the explanatory additional form...
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Railfan
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by Railfan » Thu Sep 14, 2017 10:49 am

The Wizard said:
pay more tax in the first three to six months of the year than the last six months
That sounds like good advice. I'll do that. Probably explains why I had a (miniscule) penalty last year - did a conversion late in December and the tax payment for it in early January.

FactualFran
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by FactualFran » Thu Sep 14, 2017 2:33 pm

The answer to the question posed in the opening post: "Is this an acceptable (to the IRS) way of paying my estimated tax?" is maybe.

After you file tax return for the year the IRS will check if the amount withheld (and only withheld, not including the estimated payments) was
  • more than the income tax for the year minus $1,000
  • at least the required annual payment, which is the smaller of 1) 90% of the income tax for the year and 2) the maximum required annual payment based on the prior year's tax (also called the safe harbor amount).
If either of those is true, there is no underpayment penalty. Otherwise, the IRS will calculate the underpayment penalty for each quarter, as is done in Part IV of Form 2210. That calculation will include the estimated payments made for each quarter.

It may be possible to reduce or eliminate the IRS calculated underpayment penalties by completing the Schedule AI—Annualized Income Installment Method of Form 2210. Schedule AI requires you to calculate the income tax based on the actual income you had per quarter, which can take a good deal of time. Without a Schedule AI from you, the IRS treats the income for the year as having been spread evenly among the quarters.

Swimmer
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by Swimmer » Thu Sep 14, 2017 3:30 pm

I guess ignorance is bliss. Until last year, I simply filed a 4th Q ES to cover a late year conversion. I probably did this 8 times, feeling like I was acting in good faith. Never a single objection from the IRS. Shhh :shock:

Afull
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by Afull » Thu Sep 14, 2017 7:51 pm

Railfan wrote:
Thu Sep 14, 2017 8:14 am
To go into just a little more detail, I don't really mean for it to sound like it's all unplanned and haphazard: what I'm thinking is to use share-price averaging to move the money out of the traditional IRA, much like dollar-cost averaging in. If the market stays relatively stable, I plan to convert a defined dollar amount each quarter that will keep me within my pre-planned tax bracket range. On the other hand, it seems pretty frothy to me, and if it took a tumble I might temporarily bite the bullet on the tax bracket limit to be able to convert a relatively larger number of shares out of the traditional for the same dollar while the price is low(er). I'm not trying to time the market for a fall but just keeping my options open.
Spoken like a true market timer...(only an attempt at humor not criticism). In the years I've been doing conversions I had a couple years where I was doing something similar to you. Then some years I'm thinking market is up most years so do it all at the beginning of the year and get that years gains tax free. But my experience since my first conversion in 2009 it doesn't make a big difference overall unless you just happen to time it badly with respect to a huge drop like occured in 2008, which in those years you should do it at the end of the year. But the cool thing about that conversion you did at the beginning of the year before a big drop in prices you can undo it and then convert more shares that same year. Has to be different money & managing accounts is critical to keep re characterized money separate from other TIRA money. I usually opened a new TIRA for recharacterized money to be safe.

So I'm still tweaking (market timing) what I do every year, but so far it's not made a lot of difference.

With respect to taxes, before I started SS, I did do the quarterly estimated tax I just didn't work too hard to avoid the penalty, I was ok with owing some with a penalty. Note that, imho, the "penalty" is a misnomer. You are simply paying interest on each day you are in arrears with the IRS and it usually works out to not that much.

MotoTrojan
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by MotoTrojan » Thu Sep 14, 2017 11:00 pm

I'd just withhold from paycheck to get above last years taxes.

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midareff
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by midareff » Fri Sep 15, 2017 6:42 am

FIREchief wrote:
Wed Sep 13, 2017 10:39 pm
Why not do the entire annual conversion in January and then pay the additional taxes in four equal estimated tax installments in accordance with the IRS quarterly deadlines?
I have been doing Roth conversions the last three or four years. I use Taxcaster and H&R Block's tax forecaster to determine the highest amount I can convert and remain at 15%, then establish my EFTPS for the four quarters at the amount needed. Since they tend to be a bit conservative I usually wind up with a small refund.

TonyDAntonio
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by TonyDAntonio » Fri Sep 15, 2017 8:50 am

Swimmer wrote:
Thu Sep 14, 2017 3:30 pm
I guess ignorance is bliss. Until last year, I simply filed a 4th Q ES to cover a late year conversion. I probably did this 8 times, feeling like I was acting in good faith. Never a single objection from the IRS. Shhh :shock:
I am planning on doing this for the first time this year. I did my first small conversion late last year and just reconciled the taxes when I did my return (early this year). This year's conversion will be much larger and will require a tax payment before I do my taxes. I had no idea that I should have been filing quarterly estimated taxes for a conversion that was going to take place at the end of the year. Seems crazy...like a lot of the tax laws.

pshonore
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by pshonore » Fri Sep 15, 2017 9:09 am

You are supposed pay the tax when the income was received. If you converted a large sum in Q4, thats when the tax is due. The easiest way to resolve this is through withholding from a pension, SS, or wages. Failing that, Form 2210 using the AI method will straighten things out but that form is as much fun as going to the dentist.

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Railfan
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by Railfan » Fri Sep 15, 2017 10:17 am

After reading the responses to my question, looking over the forms mentioned and reassessing how my monthly income stream would be affected, perhaps increasing the withholding from my monthly pension check, while crimping my cash flow somewhat, might not be as impractical as I first thought (I mean, mostly it was a mental block - that tax money has to come from somewhere, be it the monthly check or out of the bank account). It also occurs to me that doing it that way to cover conversions will be useful once I start having to take my RMDs, and my wife's a year later as well. I may be doing further conversions then as well.

I appreciate the responses I've gotten on this - it's informed my understanding of the subject, reminded me of alternative options and possibly kept me from making a costly mistake down the line.

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FIREchief
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Re: Use IRS Direct Pay for estimated tax payments on irregular Roth conversions?

Post by FIREchief » Fri Sep 15, 2017 5:53 pm

Railfan wrote:
Fri Sep 15, 2017 10:17 am
it's informed my understanding of the subject, reminded me of alternative options and possibly kept me from making a costly mistake down the line.
Of all the financial "mistakes" a person can make, underpayment of estimated taxes is likely among the most benign. Worst case scenario is having to fill out one more IRS form and/or borrow money from the fed at a 4% APR. (I think it is currently 4%, but I haven't looked lately)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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