Avoiding the Underpayment Penalty for Quarterly Estimated Tax Payments

March 14, 2016 : Monica Welsh

Many self-employed and small business owners are required to pay estimated tax payments throughout the year. If these quarterly estimated payments are not calculated correctly, you run the risk of underpayment. The underpayment of estimated payments may result in a penalty, which can be pretty steep.

Below you will find a list of the best ways to avoid underpayment, and when underpayment is unavoidable, ways to avoid the penalty. 

Safe Harbor Payments

Generally, an underpayment penalty can be avoided if you make one of the safe harbor payments described below. The IRS will not charge an underpayment penalty if you pay at least:

  • 90% of the tax you owe for the current year, or
  • 100% of the tax you owed for the previous tax year.

This rule is altered slightly for high-income taxpayers. If the adjusted gross income on your previous year’s return is over $150,000 (over $75,000 if you are married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.

However, if you do not pay at least that much via quarterly estimated payments, you may be subject to an underpayment penalty.

Relief for Underpayment Due to Premium Tax Credit (PTC)

If you had Marketplace health insurance and received advanced premium tax credit payments to reduce your premiums, the advance payments from the insurance provider may have exceeded the amount of PTC that you can take. This excess may have caused an underpayment of your estimated tax and thus, made you subject to the underpayment penalty.

However, the penalty can be waived if you meet the following requirements:

  • You are considered current with your tax filings and payment obligations if you filed all your required tax returns, and
  • You have paid or are paying your tax liabilities

The IRS will waive the underpayment penalty caused by an excess PTC as long as the taxpayer meets the above requirements. A waiver can be requested by filing Form 2210.

Exceptions to Underpayment Penalty

Less than $1,000 Due

You will not owe the underpayment penalty if the total tax shown on your return minus the amount you paid through withholding is less than $1,000. 

No Tax Liability Last Year

You will not owe the underpayment penalty if you had no tax liability last year. Additionally, to be eligible for this exception, you must have been a U.S. citizen or resident for the entire year.

Annualized Income Installment Method

You may be able to eliminate or at least lower your penalty if you are a taxpayer that does not receive your income evenly over the course of the year. This rule generally applies to taxpayer that own or run seasonal businesses in which income fluctuates greatly throughout the year.

In order to figure your underpayment using this method you must complete Form 2210, Schedule AI. Schedule AI will annualize your tax at the end of each payment period based on your income, deductions and other items relating to events that occurred from the beginning of the tax year through the end of the period.

Penalty Waiver

The IRS will waive your underpayment penalty if you meet one of the following situations:

  • You received excess advance payment of the PTC from a Marketplace, and you are current with your filing and payment obligations (discussed above)
  • You did not make a payment because of a casualty, disaster or other unusual circumstance and it would be inequitable to impose the penalty
  • You retired (after reaching age 62) or became disabled in 2013 or 2014 and both the following requirements are met
    • You had a reasonable cause for not making the payment
    • Your underpayment was not due to willful neglect

A waiver can be filed by filling out Part II of Form 2210.

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Monica Welsh

Monica Welsh

The Tax Institute, H&R Block

Monica is a tax research analyst in the Tax Institute. She specializes in the areas of business and investment. Monica is a graduate of the University of Missouri-Kansas City School of Law with a JD and an LLM in tax.