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Old 01-31-2017, 11:50 AM
 
Location: Idaho
1,451 posts, read 1,153,447 times
Reputation: 5472

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I just finished doing my income tax returns today (had to wait until 1/31 to import tax information from Fidelity and Janus). To my surprise and confusion, I get a Federal tax refund of $4,300 but have to pay $307 in tax penalty.

I did a search on tax penalty and here is what I learned:

https://ttlc.intuit.com/questions/25...tting-a-refund

Quote:
Underpayment penalties are assessed if you don't withhold or pay enough tax on income received during each quarter.

In fact, it's entirely possible to get hit with an underpayment penalty even though you paid your tax bill in full by the April deadline or are getting a refund.

Here's an example: Joe is self-employed and estimated next year's tax bill at $20,000. Rather than making 4 quarterly payments of $5,000 apiece, he chose to pay $500 in each of the first 3 quarters, and the remaining $18,500 in the fourth quarter.

When he filed, his actual tax bill came to $17,270 and he got a $2,730 refund. However, he got hit with the underpayment penalty because he underpaid his estimated tax in the first 3 quarters.
This is exactly what happened to us because I paid most of 2016 Fed income tax in the 4th quarter.

While I was working, taxes were taken out regularly from my biweekly paychecks. I usually took single status deduction and sometimes even paid extra taxes to cover my investment income.

Last year, the bulk of my income came from Roth IRA conversions made in the 4th Q and the rest came from investment income with some major accounts which paid most of the funds' dividend and capital gains near the end of December. I had mistakenly assumed that the estimated tax payments for each quarter were based on the actual income for that quarter.

Now I know that I have to annualize my income tax by dividing my estimated 2017 taxes by 4 and pay every quarter to avoid the underpayment penalty.

I have tried to learn as much about managing my finances in retirement but have made several mistakes. Besides this error, I also did not not know that we should have applied for Medicare part B and D for my husband when we switched from my previous employer's insurance to Cobra. We ended up having to pay for the supposedly Medicare share portion for several medical procedures during this period. I also learned that you could 'negotiate' with your medical provider when the insurance company refused to pay. Upon learning that we did not have Medicare part B to pay for the fitting and cost of an ankle brace, the podiatrist office decided to directly bill us $500 instead of pursuing payments for the $3000 bill from Medicare & the Cobra insurance company.

P.S. My refund came mostly from my late HSA contribution which I did not know that I could make without an employment income (learned from CD forum discussion). The other part came from the fact that portion of the Roth IRA conversions came from post tax IRA contributions.

Last edited by BellaDL; 01-31-2017 at 12:27 PM..
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Old 01-31-2017, 12:16 PM
 
Location: Idaho
4,621 posts, read 4,460,757 times
Reputation: 9035
Wow! Sounds like there should be a mandatory "Retirees and your financial liabilities" just before someone retires. This stuff is always so complicated, and we're always on the hook for being ignorant about it.

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Old 01-31-2017, 12:26 PM
 
Location: SoCal
13,209 posts, read 6,313,926 times
Reputation: 9826
I use Turbotax to estimate incoming tax years. Like right now I have 2017 and 2018 in the works, I want to see how much IRA I can convert to Roth without hitting the limit. I'm surprised that you owe that much in penalty. I think it's safe to know if one pays more than 90% of previous tax year, one should be ok. In the past, I might owe some tax penalty in some years, but never more than $70 a year. Small price I have to pay for not paying estimated tax. But cheaper than hiring a tax preparer.
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Old 01-31-2017, 12:45 PM
 
Location: Idaho
1,451 posts, read 1,153,447 times
Reputation: 5472
Quote:
Originally Posted by NewbieHere View Post
I think it's safe to know if one pays more than 90% of previous tax year, one should be ok.
This only applies to avoiding penalty for underpayment (you have to pay 90% of previous tax year or >100% of current tax year). The penalty I got was for NOT PAYING estimated tax throughout the year.

I use Turbo Tax too but it does not help when you transition from employed tax year to retirement tax year because your source and amounts are mostly completely different.

It was a struggle for me to try to figure out how much to convert to Roth IRA because of the unpredictability of income from several funds which typically distribute Div and CG at the end of the year. Before I did the conversion in 2016, I had a spreadsheet of total Div/CG for the previous 5 years and found that it ranged from the low of $29K in 2012 to a high of $110K in 2014 (with no changes in the portfolios!). With almost 3x difference from year to year, it's difficult to decide how much to convert without putting one in the next tax bracket and medicare premium tier! This is the reason why I put off the conversion until the 4th Q last year.

Oh well, the way I see it is you loose some, you win some, and one must continuously learn about everything in life.

I just have to remember to be thankful of being lucky enough to worry about this type of financial issues instead of how to pay my rent, food, insurance or medical care.
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Old 01-31-2017, 12:48 PM
 
Location: SoCal
13,209 posts, read 6,313,926 times
Reputation: 9826
Does Turbotax tell you that amount? Mine doesn't have it right now so I'm wondering if I will have to pay it later.
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Old 01-31-2017, 12:49 PM
 
341 posts, read 170,922 times
Reputation: 434
Quote:
Originally Posted by BellaDL View Post
I just finished doing my income tax returns today (had to wait until 1/31 to import tax information from Fidelity and Janus). To my surprise and confusion, I get a Federal tax refund of $4,300 but have to pay $307 in tax penalty.

I did a search on tax penalty and here is what I learned:

https://ttlc.intuit.com/questions/25...tting-a-refund



This is exactly what happened to us because I paid most of 2016 Fed income tax in the 4th quarter.

While I was working, taxes were taken out regularly from my biweekly paychecks. I usually took single status deduction and sometimes even paid extra taxes to cover my investment income.

Last year, the bulk of my income came from Roth IRA conversions made in the 4th Q and the rest came from investment income with some major accounts which paid most of the funds' dividend and capital gains near the end of December. I had mistakenly assumed that the estimated tax payments for each quarter were based on the actual income for that quarter.

Now I know that I have to annualize my income tax by dividing my estimated 2017 taxes by 4 and pay every quarter to avoid the underpayment penalty.

I have tried to learn as much about managing my finances in retirement but have made several mistakes. Besides this error, I also did not not know that we should have applied for Medicare part B and D for my husband when we switched from my previous employer's insurance to Cobra. We ended up having to pay for the supposedly Medicare share portion for several medical procedures during this period. I also learned that you could 'negotiate' with your medical provider when the insurance company refused to pay. Upon learning that we did not have Medicare part B to pay for the fitting and cost of an ankle brace, the podiatrist office decided to directly bill us $500 instead of pursuing payments for the $3000 bill from Medicare & the Cobra insurance company.

P.S. My refund came mostly from my late HSA contribution which I did not know that I could make without an employment income (learned from CD forum discussion). The other part came from the fact that portion of the Roth IRA conversions came from post tax IRA contributions.
Well this is news to me too. We will be retiring this year so your tax situation and education is eye opening.

So, are you saying for example: We take no income but covert 50,000 in December 2017 to a ROTH that we are required to make quarterly tax payments even though we had no income (conversion) until the last month of 2017? So you are required in ^^^^ case to pay your taxes before you receive the income?
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Old 01-31-2017, 12:53 PM
 
Location: 5,400 feet
2,618 posts, read 2,574,908 times
Reputation: 3667
There is a 'safe harbor' for estimated tax payments. If you pay at least as much in the current year as your tax liability was in the prior year (and do so quarterly), then there will be no penalty. If your income in 2017 will exceed $150K, then the safe harbor is 110% of 2016 tax liability.
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Old 01-31-2017, 01:01 PM
 
Location: Idaho
1,451 posts, read 1,153,447 times
Reputation: 5472
Quote:
Originally Posted by littlebebe View Post
Well this is news to me too. We will be retiring this year so your tax situation and education is eye opening.

So, are you saying for example: We take no income but covert 50,000 in December 2017 to a ROTH that we are required to make quarterly tax payments even though we had no income (conversion) until the last month of 2017? So you are required in ^^^^ case to pay your taxes before you receive the income?
Yes!!! This is what I just learned today!

I would like to emphasize that the 'safe harbor' for estimated tax payment cited by other posters only works to avoid penalty for underpayment the entire year tax liability.

Like in our case and the example from TTTax webpage, you could overpay the taxes and get a refund and still get a penalty for not spreading out the estimated tax liability payment over 4 quarters.
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Old 01-31-2017, 01:10 PM
 
341 posts, read 170,922 times
Reputation: 434
Quote:
Originally Posted by BellaDL View Post
Yes!!! This is what I just learned today!

I would like to emphasize that the 'safe harbor' for estimated tax payment cited by other posters only works to avoid penalty for underpayment the entire year tax liability.

Like in our case and the example from TTTax webpage, you could overpay the taxes and get a refund and still get a penalty for not spreading out the estimated tax liability payment over 4 quarters.
Well, I guess getting a crystal ball will help determine the correct quarterly tax. When you have so many different places of distribution it seems like a major pita. Or you could be like doctors now with the HDHP just make me overpay in advance so I can ask for my overpayment later.

Can't wait to see how we will fair after a full year of retirement income.
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Old 01-31-2017, 01:30 PM
 
3,751 posts, read 9,600,559 times
Reputation: 7039
There are exceptions for earning unequal income in the later quarters and the first year after retirement.

I included the first page summary from IRS.gov.

https://www.irs.gov/taxtopics/tc306.html

Here is the form that you would fill out to see if there is an automatic penalty waiver. See page 4 for the annualized method.

https://www.irs.gov/pub/irs-pdf/f2210.pdf
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