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Underpayment of Estimated Tax

The U.S. tax system is a pay-as-you-go system. You're usually required to make tax payments as you earn income. Make estimated quarterly payments if either applies:

  • Your employer doesn’t withhold taxes from your paycheck.
  • Your withholding doesn’t cover all your income.

Estimated tax payments for 2014 are due:

  • April 15, 2014
  • June 17, 2014
  • Sept. 16, 2014
  • Jan. 15, 2015

To learn more, see the Estimated Tax (Form 1040-ES) tax tip.

You might pay an underpayment penalty if both of these apply:

  • You don't make estimated tax payments during the year.
  • The amount you’ve withheld from other income is less than 90% of your tax bill.

To avoid an underpayment penalty, make estimated tax payments if:

  • You have self-employment income.
  • You have other income taxes aren’t withheld from.

For the examples below, assume the following about Craig:

  • He's single.
  • He claims one allowance on the Form W-4 he files with his employer.
  • He claims the standard deduction on his return each year.
  • He claims his personal exemption on his return each year.
  • He files his return on April 15 each year.

Ex: Craig earns $20,000 a year from his own part-time business. Last year, he also worked for an employer full-time and earned $45,000, so he chose to have an additional $7,000 withheld from his paycheck in addition to what his employer was required to withhold. It was the right amount to cover his taxes for his $65,000 income. He even received a refund.

However, this year he only worked for his employer part-time -- earning $30,000. He had only $3,000 of additional withholding for the year from his paychecks. Craig decided to put some extra time in his business and earned $30,000 in income this year. He planned to pay whatever he owed when he filed his return. However, he had to pay underpayment penalty of $96 along with the taxes he owed.

The IRS uses this system to figure your penalty payment:

  1. When you file your return, the IRS calculates how much tax you should have paid each quarter.
  2. The IRS applies a percentage (the penalty rate) to figure your penalty amount for each quarter.
  3. The penalty amount for each quarter is totaled to come up with the underpayment penalty you owe.

Ex: Craig’s gross income for 2013 is $60,000. Based on our assumptions, he’ll owe about $11,713 in taxes. This includes self-employment tax on his $30,000 business income. He had withholding of $6,168, including $3,000 of additional withholding during the year. He’ll pay the $5,545 shortfall and the $96 penalty.

Have the IRS Figure Your Penalty

If you underpaid your tax, you can have the IRS figure your penalty if:

  • You didn’t start withholding enough tax by year’s end.
  • The exceptions don’t apply to you.
  • You didn’t file Form 2210.

It usually won't cost any more to have the IRS figure the penalty if you pay the amount due by the date specified on the IRS bill. In certain cases, you might be required to file Form 2210.

Exceptions to the Penalty

The IRS won't assess a penalty if certain exceptions apply. If you qualify for an exception, estimated tax payments aren’t the same as withholding.

Exceptions for the penalty are:

  • The total of your withholding and estimated quarterly tax payments was at least as much as your prior-year tax.
  • You had no tax liability last year, and you were a U.S. citizen or resident alien for the whole year.
  • You owed some tax last year, and you had that amount or more of tax withheld from your paychecks this year. However, if your adjusted gross income (AGI) was more than $150,000 -- or $75,000 if married filing separately -- you must pay at least 110% of last year's tax.
  • You had at least 90% of this year's tax withheld from your paychecks.
  • The amount you owe this year is greater than your withholding by no more than $1,000 .
  • You didn’t have any withholding taxes, and your 2013 tax is less than $1,000 .

Ways to Lower or Eliminate the Penalty

If the exceptions don’t apply to you, you still might reduce the penalty you owe -- or avoid the penalty altogether. To do this, you must file Form 2210.

File Form 2210 if any of these apply:

  • Your estimated quarterly payments were adequate and timely for your tax situation. Ex: You owed $20,000 in tax and you paid $5,000 every quarter.
  • You generated a large part of your income later in the year. Ex: You sold an investment in December and generated a gain.
  • A large part of your tax payments occurred earlier in the year. Ex: You applied a large overpayment from last year's return to this year's taxes.
  • Your filing status changed to or from married filing jointly. If you married this year and both filed as single last year, you can usually combine last year's tax on your return and last year's tax on your spouse's return. See Publication 505: Tax Withholding and Estimated Tax or Form 2210 instructions if both of these apply:
    • You filed a joint return last year.
    • Your 2013 filing status isn’t married filing jointly.
  • You’re a farmer or fisherman, and your withholding plus quarterly estimated tax payments are at least 66 and 2/3 of your 2013 tax.
  • A casualty or disaster occurred, making it unfair for the IRS to impose the penalty. Attach a statement to your return to explain the casualty or disaster.
  • You're retired or disabled, and your underpayment was due to a reasonable cause rather than willful neglect. Attach a statement to your return explaining what caused the underpayment.

Avoiding a Penalty by Changing Your Withholding

If you discover before the end of the year that you’ll owe more taxes than you’re withholding, you can file a new W-4 form with your employer.

If at the end of 2013 you’ve withheld the full amount of taxes, you won’t be penalized.

You won't get the same result by making an estimated payment. If you make an estimated payment late in the year, the date matters when calculating the penalty.

Ex: Craig has had $2,600 in taxes withheld by late September. He finds he needs to pay another $6,600 by year’s end. If he can, he can withhold from his paycheck $2,200 in October, November, and December so he won’t pay the penalty.

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