Avoiding the Underpayment Penalty for Quarterly Estimated Tax Payments

 

Who Does the Tax Underpayment Penalty Affect?

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 ways to avoid the penalty when payments weren’t sufficiently made.

Can You Avoid the Tax Underpayment Penalty?

underpayment

You can avoid the tax underpayment penalty by making sure that your quarterly estimated payments are paid in full and on time. Here is more information on each of the options to avoid paying a penalty for not paying your taxes in full.

Safe Harbor Rule & Payment Information

Generally, an underpayment penalty can be avoided if you use the safe harbor rule for 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.

Exceptions to the Tax 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 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 the current or prior tax year 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.

Related Topics

Related Resources

IRS Notice CP504B – Notice of Intent to Seize Your Property or Rights to Property

Learn more about notice CP504B and how to handle an IRS bill for unpaid business tax with help from the tax experts at H&R Block.

Tax Refunds And Student Loans

Learn whether the payment status of your student loans entitles the IRS to take your tax return from the tax experts at H&R Block.

IRS Notice CP87B – Verify You are Not Someone’s Dependent

Learn about IRS Notice CP87B, why you received it, and how to verify a dependent on your tax return. Get tax help from the tax experts at H&R Block.

How to Get More Time to Respond to a CP2000 Notice

If you need more time to respond to an IRS CP2000 notice, ask the IRS to extend the notice deadline. Learn exactly what to do to get more time from the IRS.