04 Oct When do I have to pay tax on a Roth conversion?

Q. If I roll over $100,000 on Jan 10, 2022 from a traditional IRA to a Roth — for tax year 2022 — when do I need to pay the tax? For example, if I’m in the 24% tax bracket, do I pay $24,000 immediately or can I make estimated quarterly payments of $6,000 each?
— Want to do it right

A. The tax liability on a Roth conversion is one of the most important considerations before you make a move.

Where will that tax payment come from?

You do want to make sure you have sufficient assets outside of the IRA to pay the resulting taxes, said Cynthia Fusillo, a certified public accountant with Peapack Private Wealth Management in New Providence.

“Your planned conversion, while set to occur early in the year, does not necessarily mean the resulting tax liability has to be paid at the same time,” she said. “Converting earlier in the year may allow you more time to pay the taxes, because, in general, taxes are due upon filing the tax return for the year in question.”

Your 2022 tax return is due April 15, 2023, so, potentially, you could delay paying the conversion tax in part or in whole until that time.

As you noted, some taxpayers must make quarterly estimated tax payments, Fusillo said.

“Generally speaking, this is necessary when you have sources of income that are substantial enough and that are not covered by withholding,” she said. “Some examples would be investment income, self-employment income, and rental income, just to name a few.”

In addition, there are two methods to base the calculation of your estimated payments and avoid a penalty for underpayment of estimated tax, she said.

First, you can pay on a safe harbor basis.

This means you must cover 100% of your prior year tax liability in the current year — 150% if your adjusted gross income exceeds $150,000 — in order to avoid the underpayment penalty, she said.

“This is a popular method and works well when your income tends to be consistent,” Fusillo said. “It’s easy to calculate and requires no guesswork. Your four quarterly payments will be the same amount.”

The other method is to cover 90% of your anticipated current year tax liability — it’s 80% for New Jersey.

“This works well if you have a sudden drop in your income, not consistent with the prior year, but are still required to make quarterly payments,” she said. “This does require that you forecast your income and calculate the resulting tax on a quarterly basis, and each estimated payment could change as your forecast changes.”

Now to answer your specific question.

If you are already in the habit of making quarterly estimated payments, then you will continue to do so, Fusillo said.

Your Roth conversion will mean your anticipated 2022 income is likely higher than it will be in 2021. Therefore, you would more than likely use the safe harbor method and cover your 2021 tax liabilities — at either 100 or 110% again depending on your adjusted gross income — when making your 2022 quarterly estimated payments, she said.

“Any additional tax owed due to your 2022 Roth conversion would be due April 15, 2023,” she said. “If, however, your 2022 income is not a good deal higher than it is in 2021, then you could utilize the 90% method and estimate your payments that way.”

You should consult with a tax advisor who can go over how the rules affect your specific circumstances.

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This story was originally published on Oct. 4, 2021.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.