How the safe harbor for estimated tax can help you avoid underpayment penalties

 

Not paying enough in estimated tax payments can mean unpleasant penalties. Luckily, in some cases you may be able to avoid paying them thanks to the estimated tax safe harbor.

If you’ve not heard about the IRS safe harbor rules for paying estimated taxes, you can find out about those here and see if they apply to you.

What is a safe harbor rule?

The term “safe harbor” means that through law, you’re protected from a penalty when conditions are met. While the term applies to many areas of law, a major application of it is in taxation.

Safe harbor can be applied to estimated taxes giving you some leeway in how much you need to pay. And, if certain conditions are met, your penalty is waived or reduced.

Estimated tax payment safe harbor details

The safe harbor estimated tax has three components, which we’ll outline here.

Generally, an underpayment penalty can be avoided if you use the safe harbor rule for payments described below. The IRS will not charge you 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, or
  • You owe less than $1,000 in tax after subtracting withholdings and credits

This rule is altered slightly for high-income taxpayers. If the Adjusted Gross Income (AGI) 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.

Your state will also have estimated tax payment rules that may differ from the federal rules.

How to determine if you can reduce or avoid the underpayment penalty

If you don’t qualify for the safe harbor instances above, you may owe a penalty. Fortunately, there are ways to lessen or completely avoid the underpayment penalty.

Annualized income installment method

You can eliminate or lower your penalty if you don’t receive your income evenly over the course of the year. For example, this rule generally applies to taxpayers that own or run seasonal businesses in which income fluctuates greatly throughout the year. Examples of large fluctuations in income could be from retirement withdrawals, income changes during the year, or bunching up deductions.

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:

  • Didn’t pay because of a casualty, disaster, or other unusual circumstance that would be unfair to impose the penalty, or
  • You retired (after reaching age 62) or became disabled in the current or prior tax year and:
    • 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 and attaching the required documentation detailed in the Form 2210 instructions.

More help understanding the IRS safe harbor rules

IRS safe harbor rules related to estimated tax payments can get tricky. For hands-on tax guidance, learn about the many ways to file with H&R Block.

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