A Tax Question: Why Did I Get a Refund and an Underpayment Penalty?

[question everything]

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: 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.

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https://archive.is/wpwkL#selection-5593.0-5593.67

[twodogsbarking]

1. I think the form will ask when you got the money and them match it to the quarter.

They don't want people taking the money early in the year and paying the tax later. Oddly enough if you have all of your W2 withholding at the end of the year they don't test (unless this has changed). When you withdraw (or convert) tax deferred investments they look at the time frames. Get the IRS form and follow the instructions to see how it works out. Hope this makes sense. Good luck.

[Freethinker65]

2. Interesting, that happened to us with massive capital gains paid out in December a few years ago

We paid the penalty, and have been filing estimated quarterly taxes since. Last year instead of giving us all of our overpayment, the IRS kept some to pay the first quarterly estimated payment for 2023.

I will wait and see what happens this year. My husband has since retired. We were considering converting some IRAs to Roths as well.

[mahatmakanejeeves]

3. Thanks for that. I made an estimated payment at the end of 2022, but it still wasn't enough.

Not for my federal taxes, that is.

For Virginia, I made an estimated payment at the end of 2022, and it was more than enough. I still had to pay a penalty to Virginia. Not a lot, but still. I need to challenge that.

Thanks again.