Penalty for Underpayment of Estimated Taxes
The IRS is structured on a “pay as you go” system. This means they expect to receive tax payments throughout the year, not just annually when tax returns are filed. Because of this, taxpayers may be required to make estimated tax payments throughout the year. When taxpayers do not pay enough throughout the year, either through withholdings or estimated tax payments, they may be charged a penalty.
The penalty is calculated separately for each installment due date therefore, you may owe the penalty for an earlier due date even if you paid enough tax later in the year to compensate for the underpayment. This is true even if you are due a refund at the time of filing.
Can it be Waived?
Typically, the penalty for underpayment of tax can be waived if the taxpayer meets one of the following situations:
- – The balance owed is less than $1,000.
- – Withholdings and estimated tax payments amount to at least 90% of the balance due.
- – The taxpayer was not required to file the previous year (and therefore had zero tax liability).
- – Withholdings and estimated tax payments amount to at least 100% of the tax on the prior year’s return.
- – Withholdings and estimated tax payments amount to at least 110% of the tax on the prior year’s return for taxpayers with an adjusted gross income (AGI) of over $150,000 ($75,000 if married filing separate).
- – Required payments were not made because of a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty
- The taxpayer retired (after reaching age 62) or became disabled during the tax year for which estimated payments were required to be made or in the preceding tax year, and the underpayment was due to reasonable cause and not willful neglect.
If a taxpayer does not meet any of these waivers, they may be required to pay the penalties for underpayment of taxes. These penalties are calculated separately for each required installment. Once the number of days late is determined, it is multiplied by the effective interest rate for the installment period. The Underpayment of Estimated taxes are calculated on Form 2210 (https://www.irs.gov/pub/irs-pdf/f2210.pdf).
It should also be noted that if a taxpayer receives income unevenly during the year, they may be able to vary the amounts of the payments to avoid or lower the penalty by using the annualized installment method. (See form 2210 for further instructions)