Converted traditional 401k to Roth 401k; how to handle W4?

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trip666
trip666 Member Posts: 4 Newcomer
edited January 9 in Income

I (regrettably) converted my 401k which contained Pre-Tax and After-Tax money into a Roth 401k, meaning I need to pay taxes on the Pre-Tax and After-Tax gains as it they were income. This was done in Jan 2024.

My understanding is after I file taxes for 2023, I need to look at my 2023 Form 1040 and view line 24 (total taxes). Then I need to view my paystub to see how much will be federally held by my employer. If the amount withheld by my employer is equal or greater than line 24 of my 2023 Form 1040, I don't need to do anything until April 2025 where I will have to pay the taxes on my additional income from my 401k conversion.

If the amount withheld is less than line 24 of my 2023 Form 1040, I will need to add withholdings to my W4 line 4c to withhold from each paycheck the difference in value between my 2023 Form 1040 line 24 and my employer's federal withholding.

Is this correct?

Answers

  • AlexO
    AlexO FreeTaxUSA Agent Posts: 74
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    Hello, trip666!

    That is a great question!

    It sounds like you're referencing the safe harbor for avoiding an underpayment penalty. If so, you are correct in that if you prepay, either through withholdings or estimated tax payments, 100% of your 2023 tax or 90% of your 2024 tax, whichever is less, you won't be subject to the underpayment penalty. However, keep in mind that if your 2023 AGI is more than $150,000, $75,000 if filing separately, you need to prepay 110% of your 2023 tax instead of 100%.

    Considering that it's difficult to know at the moment if your 2024 withholdings will be enough, you may want to look into making an estimated tax payment with the IRS.

  • trip666
    trip666 Member Posts: 4 Newcomer
    edited January 9
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    Thank you Alex. I am interested in making an estimated tax payment, but I have a question.

    I am single with a 2023 AGI less than $150,000.

    For example, in 2024 I converted $50,000 from pre-tax to Roth in my 401k. I am in the 24% federal tax bracket, so I will have to pay $12,000 in federal taxes in 2025 for this conversion.

    My 2023 total federal tax is $20,000. So I can divide $20,000 into 4 quarterly estimated tax payments in 2024 to avoid the withholding penalty, correct?

    My question is after I pay 100% of $20,000 as quarterly estimated tax payments, do I still need to pay the $12,000 (from the 401k conversion) in 2025? Or will I get a refund of $8,000 in 2025 since the quarterly payments cover the 401k conversion taxes?

    I hope this example makes sense. Thank you again.

    Edit: I forgot to mention that my W2 salary has increased from 2023 into 2024, which is why I believe I could potentially be covered with my employer's federal withholdings being greater than 2023's total tax, therefore I may be okay without making estimated payments or adjusting my W4.

  • rachels
    rachels FreeTaxUSA Agent Posts: 51
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    Hi!

    Assuming that you are still having federal tax withheld from your W-2 wages, you likely will not need to make $20,000 in estimated tax payments. You can look at the tax withheld on your 2023 W-2 to get an idea of how much tax will be withheld in 2024. If you assume that the same amount will be withheld in 2024 (though the amount may be higher if you earn more in 2024), that will reduce the estimated tax you may have to pay. For example, if your 2023 W-2 shows that you had $15,000 tax withheld during the year, then you would only need to pay an additional $5,000 in 2024 to hit that $20,000 threshold.

    That being said, if you overpay your tax through quarterly estimated tax payments, you will be refunded any extra when you file your 2024 return next year. On your tax return, all of the tax you paid throughout the year (withholdings, estimated payments, etc.) will be added together and put toward your tax liability. If you paid more tax than you are liable for, you will be refunded the difference when you file your tax return.

  • trip666
    trip666 Member Posts: 4 Newcomer
    edited January 10
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    Hi Rachel,

    Thank you for clarifying. I think I understand. Since I do not have my 2023 W2 yet or have a completed 2023 Form 1040, I will use previous year's as an example.

    2021's Form 1040 line 24 (total tax owed) is $12,000.

    2022's W2 line line 2 (federal tax withheld) is $17,000.

    (My W2 salary increased from 2021 → 2022).

    In this situation, because 2022's federal withheld tax ($17,000) is greater than 2021's total tax ($12,000), I would not have needed to make any estimated tax payments or adjust my W4, is that correct?

    I believe I will be in a similar situation for 2024, but I will confirm once I get my 2023 W2 and see the completed tax return on my 2023 Form 1040.

  • MatthewD
    MatthewD FreeTaxUSA Team Posts: 247
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    Hi Trip666,

    Yes, generally when you pay more tax withholdings in the current year than you owed in taxes from the prior year, you would not have to pay estimated taxes. That is assuming your income didn't change much or reach a certain threshold. However, you mentioned your pay increased.

    Keep in mind there are 3 requirements the IRS has for paying estimated taxes to avoid any underpayments penalties. This is the smaller of:

    1. You owe less than $1,000 in tax after subtracting withholdings and credits, or
    2. You paid at least 90% of the tax for the current year, or
    3. You paid 100% of the tax shown on the return for the prior year (special rule applies to higher income taxpayers).

    So, ask yourself each question:

    • Will I owe less that $1,000 in tax after subtracting withholdings and credits? If so, then you don't have to pay estimated taxes.
    • Did my tax payments, withholdings and refundable credits equal at least 90% of the tax shown on my return? If so, then you don't have to pay estimated taxes.
    • Will my tax payments, withholdings and refundable credits be at least 100% of the tax shown on my prior year return. If so, then you don't have to pay estimated taxes.

    Please note this rule for Higher Income Taxpayers, "If your AGI for 2022 was more than $150,000 ($75,000 if your filing status for 2023 is married filing a separate return), substitute 110% for 100%"

    If you answer, NO, to any of those question, you may need to pay estimated taxes to avoid any underpayment penalties.

    For more information see IRS publication 505. See the chart on Chapter 2. Estimated Tax.

    Also see this IRS FAQ on Estimated Taxes.

  • trip666
    trip666 Member Posts: 4 Newcomer
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    Thanks Matthew. This is for the upcoming 2024 year.

    "So, ask yourself each question:

    • Will I owe less that $1,000 in tax after subtracting withholdings and credits? If so, then you don't have to pay estimated taxes.
    • Did my tax payments, withholdings and refundable credits equal at least 90% of the tax shown on my return? If so, then you don't have to pay estimated taxes.
    • Will my tax payments, withholdings and refundable credits be at least 100% of the tax shown on my prior year return. If so, then you don't have to pay estimated taxes."
    1. No / not likely
    2. No / not sure
    3. Yes

    I checked the link you provided for IRS publication 505 and it mentions "In most cases, you must pay estimated tax for 2023 if BOTH of the following apply.

    1. You expect to owe at least $1,000 in tax for 2023 after subtracting your withholding and tax credits.
    2. You expect your withholding and tax credits to be less than the smaller of:
      1. 90% of the tax to be shown on your 2023 tax return, or
      2. 100% of the tax shown on your 2022 tax return. Your 2022 tax return must cover all 12 months."

    In my situation 1. may be true, but 2b. will be false. Therefore both do not apply, meaning I will not have to pay estimated tax for 2024 and will avoid the withholding penalty. Is this correct?

  • MatthewD
    MatthewD FreeTaxUSA Team Posts: 247
    edited January 15
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    Hi Tripp666,

    Then you may need to make some estimated tax payments. Keep in mind that if you answer NO to any of those you may need to pay estimated tax payments. I recommend you use this IRS Interactive Assistant, "Am I Required to Make Estimated Tax Payments?"/ Click on the link and then Begin. It takes about 10-15 minutes and will have a recommendation for you.