Understanding the penalty for underpayment of estimated tax

 

U.S. tax operates as a pay-as-you-go system. Many employees pay taxes through paycheck withholding. But if withholding doesn’t apply to you or it won’t cover all your tax obligations, you may need to pay estimated taxes quarterly. But what happens if you fail to pay proper estimated taxes, or not at all? Unfortunately, you could end up with a penalty for underpayment of estimated tax.

underpayment of estimated tax

To understand what can trigger a penalty, lets cover the details.

For starters, adequately paying quarterly taxes by the dates below will help keep you from incurring the penalty for underpayment of estimated tax. For calendar year taxpayers:

  • April 15
  • June 15
  • Sept. 15
  • Jan. 18 of the following year

Want to learn more about how you may be able to avoid this penalty? Check out our estimated tax safe harbor post.

What is the underpayment of estimated tax? 

Underpayment of estimated tax occurs when you don’t pay enough tax during those quarterly estimated tax payments. Failure to pay proper estimated tax throughout the year might result in a penalty for underpayment of estimated tax. The IRS does this to promote on-time and accurate estimated tax payments from taxpayers. 

When doesn’t the estimated tax penalty apply?

The good news is the IRS will not assess a penalty for underpayment of estimated tax if certain exceptions apply. You may qualify for an exception to the penalty if you:

  • Have no tax liability during the prior year, you are a U.S. citizen, and your prior tax year covered a 12-month period, or
  • Experience an unforeseen, uncommon, or noteworthy event such as a casualty or disaster
  • Retired at age 62 or older during the prior or current tax year, and
    • Had reasonable cause for not making the payment, and
    • The underpayment was not due to willful neglect.
  • Became disabled during the prior or current tax year
  • Qualify for the estimated tax safe harbor

The “estimated tax safe harbor” rule means that if you paid enough in tax, you won’t owe the estimated tax penalty. Here are the rules:

  1. If you pay 90% or more of your total tax from the current year’s return or 100% of your tax from the prior year, or you owe less than $1,000 in tax after withholdings and credits.
  1. If your adjusted gross income was $150,000 or more (or $75,000 if you’re married filing separately) then you may not be subject to the penalty if you paid the lower of 90% of the tax shown on the current year return, or 110% of your tax from the prior year.

What is the penalty for underpayment of estimated taxes? 

If you’re questioning, “What is the penalty for underpayment of estimated tax?”, it’s not a static percentage or flat dollar amount.

Here’s what will happen and how your late estimated tax penalty will be calculated.  The IRS will send a notice if you underpaid estimated taxes. They determine the penalty by calculating the amount based on the taxes accrued (total tax minus refundable tax credits) on your original return or a more recent one you filed.

Specifically, the IRS calculation for the penalty is based on the:

  • Total underpayment amount 
  • Period when the underpayment was underpaid
  • Interest rate for underpayments (This number changes each quarter. View the IRS’ Interest on Underpayments and Overpayments page for specific numbers.)

Form 2210 (or Form 2220 for corporations) will help you determine the penalty amount. You should figure out the amount of tax you have underpaid. This form contains both a short and regular method for determining your penalty.

To calculate the penalty yourself (other than corporations): 

You can let the IRS figure your penalty if:

  • You didn’t withhold enough tax by the end of the year.
  • You aren’t required to file Form 2210 (box B, C, or D in Part II doesn’t apply to you).

Get help with the penalty for underpayment of estimated tax

Determining estimated tax is not the most straightforward tax topic. For hands-on tax help, learn about the ways to file with H&R Block.

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