How to minimize tax witholding without a penalty?

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tadamsmar
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How to minimize tax witholding without a penalty?

Post by tadamsmar »

I have a number of questions about limiting and delaying tax withholding.

I have a pretty good estimate of my taxes each year and I am thinking about minimizing withholding. It seems to be a good idea to limit withholding and pay a large tax bill next April. I end up using estimated quarterly payments for most of my withholding during retirement.

I see that I only need to withhold 90% of my federal tax payment or last year's amount, whichever is lower.

I good chunk of my AGI is due to Roth conversions and I usually do those late in the year so that I have enough information keep below the AGI limit that will increase my Medicare Part B. That limit is around $170,000. My wife and I still do some part-time consulting so our income is a bit unpredictable.

But that AGI took about $900 out of our covid stimulus check. So I am planning to limit my AGI to $150,000 this year so that I will get additional $900 stimulus.

Does anyone know if the $900 stimulus will just directly reduce my 2020 federal income tax payment? Does that mean that I can reduce my withholding this year?

I have been making equal or even front-loaded estimated quarterly tax payments. But I am thinking about make variable payments based on my quarterly income. But I have the impression that the rules for doing that while avoiding a penalty are complicated.
Silk McCue
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Re: How to minimize tax witholding without a penalty?

Post by Silk McCue »

So you are going to forgo $20k worth of Roth conversions, a long term financial strategy, to get $900 from the IRS next year ? That seems like a poor trade off. $900 simply can't mean that much to your financial life.

I've seen nothing to suggest that the stimulus check will reduce your income tax payment. In fact doing so would throw the whole tax return calculation extremely confusing for everyone.

Cheers
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tadamsmar
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Re: How to minimize tax witholding without a penalty?

Post by tadamsmar »

Silk McCue wrote: Mon May 04, 2020 8:50 am So you are going to forgo $20k worth of Roth conversions, a long term financial strategy, to get $900 from the IRS next year ? That seems like a poor trade off. $900 simply can't mean that much to your financial life.
Does the $20k conversion mean more? Maybe you are right, but I would like to see the math. I have to pay the taxes from a taxable account that is about 1/2 capital gains. I pay 22% federal tax on the conversion and losing the stimulus is about another 5%. Not sure if the tax rate will exceed 27% for those trad withdrawals if they are done in the future.
I've seen nothing to suggest that the stimulus check will reduce your income tax payment. In fact doing so would throw the whole tax return calculation extremely confusing for everyone.
That makes sense. It will probably not be a reduction in taxes.
pshonore
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Re: How to minimize tax witholding without a penalty?

Post by pshonore »

Silk McCue wrote: Mon May 04, 2020 8:50 am So you are going to forgo $20k worth of Roth conversions, a long term financial strategy, to get $900 from the IRS next year ? That seems like a poor trade off. $900 simply can't mean that much to your financial life.

I've seen nothing to suggest that the stimulus check will reduce your income tax payment. In fact doing so would throw the whole tax return calculation extremely confusing for everyone.

Cheers
If you're getting more stimulus based on lower 2020 income, then its reasonable to figure that "credit" into your estimates of tax owed. Granted it probably won't make a major difference either way. As I understand it, any additional Stimulus amount becomes a credit in 2020 on your tax return. No different than any other credit
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Re: How to minimize tax witholding without a penalty?

Post by Silk McCue »

tadamsmar wrote: Mon May 04, 2020 9:52 am Does the $20k conversion mean more? Maybe you are right, but I would like to see the math. I have to pay the taxes from a taxable account that is about 1/2 capital gains. I pay 22% federal tax on the conversion and losing the stimulus is about another 5%. Not sure if the tax rate will exceed 27% for those trad withdrawals if they are done in the future.
Math is certainly a part of the analysis but must of course include the tax free earnings on the growth of those converted funds as well as what those funds are intended for, future spending, inheritance etc. The Secure Act of 2019 will shove your tax deferred holdings out the door over 10 years for non-spousal beneficiaries (with other noted exceptions) once you pass and that might be a part of the analysis as well.

One point to remember is that the 2017 TCJA tax rates expire in a few years and rates will revert higher based on current law.

Cheers
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Re: How to minimize tax witholding without a penalty?

Post by tadamsmar »

pshonore wrote: Mon May 04, 2020 9:58 am
Silk McCue wrote: Mon May 04, 2020 8:50 am So you are going to forgo $20k worth of Roth conversions, a long term financial strategy, to get $900 from the IRS next year ? That seems like a poor trade off. $900 simply can't mean that much to your financial life.

I've seen nothing to suggest that the stimulus check will reduce your income tax payment. In fact doing so would throw the whole tax return calculation extremely confusing for everyone.

Cheers
If you're getting more stimulus based on lower 2020 income, then its reasonable to figure that "credit" into your estimates of tax owed. Granted it probably won't make a major difference either way. As I understand it, any additional Stimulus amount becomes a credit in 2020 on your tax return. No different than any other credit
A taxpayer pays a penalty "if they paid withholding and estimated tax of at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller."

So, on which line of 1040 is the tax shown? Line 16? Line 16 is your "total tax".

If so, then this implies that you can't lower your withholding based on any expected credits that are deducted after line 16. Right?

If the tax for the current year is also line 16, then this could in principle have the curious effect of causing a person to have to pay a penalty even if they owed no taxes after all the credits. Edit: Actually, you don't have to pay a penalty if you owe less that $1000 after credits: https://www.irs.gov/taxtopics/tc306 but I guess line 16 is used in the rest of the math.
Last edited by tadamsmar on Mon May 04, 2020 11:21 am, edited 1 time in total.
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Re: How to minimize tax witholding without a penalty?

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Silk McCue wrote: Mon May 04, 2020 10:11 am
tadamsmar wrote: Mon May 04, 2020 9:52 am Does the $20k conversion mean more? Maybe you are right, but I would like to see the math. I have to pay the taxes from a taxable account that is about 1/2 capital gains. I pay 22% federal tax on the conversion and losing the stimulus is about another 5%. Not sure if the tax rate will exceed 27% for those trad withdrawals if they are done in the future.
Math is certainly a part of the analysis but must of course include the tax free earnings on the growth of those converted funds as well as what those funds are intended for, future spending, inheritance etc. The Secure Act of 2019 will shove your tax deferred holdings out the door over 10 years for non-spousal beneficiaries (with other noted exceptions) once you pass and that might be a part of the analysis as well.

One point to remember is that the 2017 TCJA tax rates expire in a few years and rates will revert higher based on current law.

Cheers
There are lots of uncertainties. If my taxable is inherited then it is totally tax-free, but I am drawing it down and paying taxes on it to do Roth conversions. I need to project the various scenarios sometime to see if and when I should be more aggressive with conversions.

This year, I figured I would just pocket the $900 credit. But maybe I should even do bigger conversions and take a temporary hit due to paying higher Medicare Part B premiums for a year or whatever the period is.
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Re: How to minimize tax witholding without a penalty?

Post by grabiner »

tadamsmar wrote: Mon May 04, 2020 9:52 am
Silk McCue wrote: Mon May 04, 2020 8:50 am So you are going to forgo $20k worth of Roth conversions, a long term financial strategy, to get $900 from the IRS next year ? That seems like a poor trade off. $900 simply can't mean that much to your financial life.
Does the $20k conversion mean more? Maybe you are right, but I would like to see the math. I have to pay the taxes from a taxable account that is about 1/2 capital gains. I pay 22% federal tax on the conversion and losing the stimulus is about another 5%. Not sure if the tax rate will exceed 27% for those trad withdrawals if they are done in the future.
With those numbers, it's worth delaying the conversion. You can convert another $20K next year at 24%, losing only $400 extra in taxes, and get the same amount into the Roth IRA.
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tadamsmar
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Re: How to minimize tax witholding without a penalty?

Post by tadamsmar »

grabiner wrote: Mon May 04, 2020 7:12 pm
tadamsmar wrote: Mon May 04, 2020 9:52 am
Silk McCue wrote: Mon May 04, 2020 8:50 am So you are going to forgo $20k worth of Roth conversions, a long term financial strategy, to get $900 from the IRS next year ? That seems like a poor trade off. $900 simply can't mean that much to your financial life.
Does the $20k conversion mean more? Maybe you are right, but I would like to see the math. I have to pay the taxes from a taxable account that is about 1/2 capital gains. I pay 22% federal tax on the conversion and losing the stimulus is about another 5%. Not sure if the tax rate will exceed 27% for those trad withdrawals if they are done in the future.
With those numbers, it's worth delaying the conversion. You can convert another $20K next year at 24%, losing only $400 extra in taxes, and get the same amount into the Roth IRA.
It’s a little different in my case since I am stopping at the AGI that triggers the Medicare Part B premium increase which is below the tax bracket limit due to the standard deduction.

But I think others could do exactly what you are saying. Some might end up with a good bit more of a relative bargain by protecting all of their stimulus payment this year and then converting more next year. I principle, a couple filing jointly could cut their conversion by 88,000 this year to get all their stimulus and the convert 2*88,000 = 176,000 next year and still be in the 24% marginal bracket.
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Re: How to minimize tax witholding without a penalty?

Post by LilyFleur »

It's definitely something to think about. I just turned 60 and was planning to empty an inherited IRA this year to make my estate less complicated for my children, and cash in some savings bonds, for the same reason. Streamlining my estate has been an important goal to me, after dealing with my mother's estate. Then next year do a big Roth conversion. Should a $1200 stimulus credit for 2020 enter into that decision? My reasons are not simply financial. I'm single, so I have limited income space to get the entire stimulus amount.
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Re: How to minimize tax witholding without a penalty?

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LilyFleur wrote: Tue May 05, 2020 1:26 pm It's definitely something to think about. I just turned 60 and was planning to empty an inherited IRA this year to make my estate less complicated for my children, and cash in some savings bonds, for the same reason. Streamlining my estate has been an important goal to me, after dealing with my mother's estate. Then next year do a big Roth conversion. Should a $1200 stimulus credit for 2020 enter into that decision? My reasons are not simply financial. I'm single, so I have limited income space to get the entire stimulus amount.
Lily, You have a good plan there. But I would hold off on doing anything at the moment and if the markets go down significantly (more than 30% from where they currently are), then do your Roth conversion this year instead and clean up the inherited next year. Big market crashes don’t come along very often and when they do, we might as well take advantage of them.

You will be glad you saved so much on the Roth conversion taxes for the amount that is converted!

If the markets don’t go down any more, you can continue with your original plan.

Don’t worry about your stimulus check. It is not taxed. It is actually a tax credit you would have received on your 2020 taxes if you didn’t get one earlier.
Last edited by celia on Tue May 05, 2020 2:08 pm, edited 1 time in total.
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Re: How to minimize tax witholding without a penalty?

Post by celia »

OP, The thread title reminded me of this method which still might be useful to you.

If you are due a big tax refund or the interest rates are so low you don’t mind ‘losing out’ on the interest, you can over-pay your taxes, then just let your refund roll-over to be applied to the following year. There’s nothing that says you have to take your refund each year.

Now, some folks will say that is just giving the IRS an interest free loan. True, but I would say not only was I going to get very interest anyways, but it simplifies my life in not having to make Estimated Tax payments.
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Re: How to minimize tax witholding without a penalty?

Post by tadamsmar »

LilyFleur wrote: Tue May 05, 2020 1:26 pm It's definitely something to think about. I just turned 60 and was planning to empty an inherited IRA this year to make my estate less complicated for my children, and cash in some savings bonds, for the same reason. Streamlining my estate has been an important goal to me, after dealing with my mother's estate. Then next year do a big Roth conversion. Should a $1200 stimulus credit for 2020 enter into that decision? My reasons are not simply financial. I'm single, so I have limited income space to get the entire stimulus amount.
Did you fail to get the full $1200 stimulus check based on your 2019 or 2018 AGI?
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Re: How to minimize tax witholding without a penalty?

Post by lstone19 »

tadamsmar wrote: Mon May 04, 2020 10:19 am A taxpayer pays a penalty "if they paid withholding and estimated tax of at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller."

So, on which line of 1040 is the tax shown? Line 16? Line 16 is your "total tax".

If so, then this implies that you can't lower your withholding based on any expected credits that are deducted after line 16. Right?

If the tax for the current year is also line 16, then this could in principle have the curious effect of causing a person to have to pay a penalty even if they owed no taxes after all the credits. Edit: Actually, you don't have to pay a penalty if you owe less that $1000 after credits: https://www.irs.gov/taxtopics/tc306 but I guess line 16 is used in the rest of the math.
The answer is in the instructions to Form 2210. But in short, it's 1040 line 14 plus certain other taxes such as self-employment tax, Additional Medicare Tax, and Net Investment Income Tax less certain refundable tax credits. I would expect that this new credit will also qualify but that's not certain.
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Re: How to minimize tax witholding without a penalty?

Post by LilyFleur »

Did you fail to get the full $1200 stimulus check based on your 2019 or 2018 AGI?
I haven't received it yet, but since I was head of household in 2018 (and did a big Roth conversion in 2019), I am waiting to file my 2019 taxes until after I receive the stimulus money. So hopefully I will receive the full $1200 based on my 2018 income. I was able to give the IRS my banking information on their online portal.

I would not have qualified based on my 2019 income because of the Roth conversion and because I am single and no longer head of household.
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Re: How to minimize tax witholding without a penalty?

Post by tadamsmar »

LilyFleur wrote: Tue May 05, 2020 2:15 pm
Did you fail to get the full $1200 stimulus check based on your 2019 or 2018 AGI?
I haven't received it yet, but since I was head of household in 2018 (and did a big Roth conversion in 2019), I am waiting to file my 2019 taxes until after I receive the stimulus money. So hopefully I will receive the full $1200 based on my 2018 income. I was able to give the IRS my banking information on their online portal.

I would not have qualified based on my 2019 income because of the Roth conversion and because I am single and no longer head of household.
If you can confirm that you are getting the full $1200 payment, then you have no need to factor it in to your 2020 decisions. The IRS is not going to claw back any of the money based on your 2020 AGI.

You can check your payment status here: https://www.irs.gov/coronavirus/get-my-payment

That site makes you think you need a lot of info to check, but if you go to the next screens you will probably only need info that you have memorized.

But I don't know if that IRS site shows it paid any sooner than your bank web site. Anyway, if you see that it is paid then I think you can be confident that it is based on your 2018 taxes. But I guess you have to file at least a 2019 estimate by 7/15 so if you check is delayed I guess they could use the 2019 numbers when they get them.
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Re: How to minimize tax witholding without a penalty?

Post by LilyFleur »

Thanks for the tip! I am supposed to get it tomorrow.
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