Tax Planning Tips: Avoid Underpayment Tax Penalty With Withholding Tax OR By Paying Estimated Tax

What is Estimated Tax?

1. Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.

2. Corporations generally have to make estimated tax payments if they expect to owe tax of $500 or more when their return is filed.

3. Visit WWW.IRS.GOV to calculate estimated tax due by using IRS Withholding Tax Estimator. 

4. Refer Publication 505, Tax Withholding and Estimated Tax.

5. For estimated tax purposes, the year is divided into four payment periods. You may send estimated tax payments with Form 1040-ES by mail, or you can pay online, by phone or from your mobile device using the IRS2Go app. Visit IRS.gov/payments to view all the options. For additional information, refer to Publication 505, Tax Withholding and Estimated Tax.

6. However You don’t have to pay estimated tax for the current year if you meet all three of the following conditions.

• You had no tax liability for the prior year

• You were a U.S. citizen or resident for the whole year

• Your prior tax year covered a 12-month period

How you can avoid Underpayment Penalty?

1. Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.

2. Corporations generally have to make estimated tax payments if they expect to owe tax of $500 or more when their return is filed.

3. Visit WWW.IRS.GOV to calculate estimated tax due by using IRS Withholding Tax Estimator. 

4. Refer Publication 505, Tax Withholding and Estimated Tax.

5. For estimated tax purposes, the year is divided into four payment periods. You may send estimated tax payments with Form 1040-ES by mail, or you can pay online, by phone or from your mobile device using the IRS2Go app. Visit IRS.gov/payments to view all the options. For additional information, refer to Publication 505, Tax Withholding and Estimated Tax.

6. However You don’t have to pay estimated tax for the current year if you meet all three of the following conditions.

• You had no tax liability for the prior year

• You were a U.S. citizen or resident for the whole year

• Your prior tax year covered a 12-month period

Once you determined  estimated tax, ensure that your withholding tax + previous estimated tax payment is ¼th of estimated tax by Apr 15, ½ of estimated tax by Jun 15, ¾ of estimated tax by Sep 15 and 100 % of estimated tax by Jan 15 (Next Year)

What is Underpayment Penalty?

1. If your tax due due is more than as stated in previous slide, then you are liable for underpayment of estimated tax. 

2. If you didn’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. 

3. The Underpayment of Estimated Tax by Individuals Interest / Penalty applies to individuals, estates and trusts if you don't pay enough estimated tax on your income or you pay it late. The penalty may apply even if we owe you a refund.

1. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. There are special rules for farmers,  fishermen, and certain higher income taxpayers. Please refer to Publication 505, Tax Withholding and Estimated Tax, for additional information. 

2. The penalty may also be waived if:

1. The failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty, or

2. You 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.

3. Taxpayers can use following forms to adjust their withholding tax by submitting following forms to the payer.

   • W-4 Employee's Withholding Certificate

   • W-4P Withholding Certificate for Periodic Pension or Annuity Payments

   • W-4R Withholding Certificate for Nonperiodic Payments and Eligible Rollover Distributions

   • W-4S Request for Federal Income Tax Withholding From Sick Pay

   • W-4V Voluntary Withholding Request

   When you need to Adjust Your Withholding Tax?

Following changes  will result current withholding less than your tax liability. 

• Change of lifestyle: 

1. Marriage

2. Divorce

3. Birth or adoption of child

4. Purchase of a new home

5. Retirement

6. Filing chapter 11 bankruptcy

• Change of wage income

1. You or your spouse start or stop working, or start or stop a second job

• Change in the amount of taxable income not subject to withholding

1. Interest income

2. Dividends

3. Capital gains

4. Self-employment income

5. IRA (including certain Roth IRA) distributions

• Change in the amount of adjustments to income 

1. IRA deduction

2. Student loan interest

3. deduction

4. Alimony expense

• Change in the amount of itemized deductions or tax credits

1. Medical expenses

2. Taxes

3. Interest expense

4. Gifts to charity

5. Dependent care expenses

6. Education credit

7. Child tax credit

8. Earned income credit