Tax Insights

Your Guide to State, Local, Federal, Estate + International Taxation

Avoiding the Underpayment Penalty

Most taxpayers are required to make estimated tax payments throughout the year. These payments are made either quarterly with a check and estimated tax coupon or with withholding from your various sources of income. Payroll withholding is the most common form of making estimated payments.

The requirement for these payments is either:

  1. 90% of the current year’s tax, or
  2. 100% of the prior year’s tax (110% for higher income taxpayers)

Taxpayers who fail to meet the payment requirements are subject to interest and penalties but you can avoid this underpayment penalty.

What do you do if you find part way through the year that you are under paid? Making a “catch-up” payment with a coupon will get you caught up for the year, but it my still leave you underpaid for the first, second and/or third quarter. Since the underpayment penalty is calculated on a quarterly basis, you may still be assessed some penalties.

Withholding taxes, however, are not credited to your account when paid but are assumed to be paid evenly throughout the year. Therefore, if you have enough time and cash flow, you could increase your payroll withholding to make up the underpayment. Since withholding is considered paid evenly throughout the year, there will be no penalties. You could theoretically have all of your withholding taken out of your last paycheck of the year and be covered.

This works particularly well for business owners who are in a position to pay themselves a bonus at year-end and withhold a large portion of it.

Not sure if you have enough paid in or how to calculate your shortfall? Call your tax advisers and ask them to run the calculations.

By Rick Schultz, CPA