CARL WATTS & ASSOCIATES

December 11, 2017

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The Estimated Tax Penalty
Each year, about 10 million taxpayers are assessed the estimated tax penalty. The average penalty was about $130 in 2015, but the IRS has seen the number of taxpayers assessed this penalty increase in recent years. The number jumped about 40 percent from 7.2 million in 2010 to 10 million in 2015.

Most of the affected taxpayers can easily reduce or, in some cases, eliminate the penalty by increasing their withholding or adjusting estimated tax payments for the rest of the year. With a little planning, you can avoid the penalty altogether.

By law, the estimated tax penalty usually applies when a taxpayer pays too little of their total tax during the year. The penalty is calculated based on the interest rate charged by the IRS on unpaid tax.

The penalty rate for the underpayment of estimated taxes may differ from year to year, and the amount of your penalty depends on your particular circumstances. The IRS interest rate is determined by the Federal short- term rate plus 3%.

In most cases, the IRS will figure any penalty that you owe for the underpayment of estimated taxes, and send you a bill for the penalty amount. However, you may need to figure the penalty yourself in certain situations.

The penalty for the underpayment of estimated taxes is figured separately for each payment period of estimated taxes. In order to figure your penalty amount, you must use IRS Form 2210, which contains both a short and regular method for determining your penalty. Essentially, you first must determine the amount of tax that you have underpaid. Form 2210 can guide you through the process of figuring your penalty amount, which is directly based on the amount of your tax underpayment.

Generally, if you do not make at least a minimum payment for a certain payment period, you will owe a penalty. Likewise, if you miss a payment for a certain payment period altogether, then you will owe a penalty from the date the payment was due until the date the payment is made.
For most people, avoiding the penalty means ensuring that at least 90 percent of their total tax liability is paid in during the year, either through income-tax withholding or by making quarterly estimated tax payments.

Keep in mind exceptions to the penalty and special rules apply to some groups of taxpayers, such as farmers, fishers, casualty and disaster victims, those who recently became disabled, recent retirees, those who base their payments on last year’s tax and those who receive income unevenly during the year.

You may want to consider increasing your tax withholding in 2018, especially if you had a large balance due when you filed your 2016 return earlier this year.

Employees can do this by filling out a new Form W-4 and giving it to their employer. Similarly, recipients of pensions and annuities can make this change by filling out Form W-4P and giving it to their payer. In either case, you can typically increase your withholding by claiming fewer allowances on your withholding form.

If that’s not enough, you can also ask employers or payers to withhold an additional flat dollar amount each pay period. For help determining the right amount to withhold, check out the Withholding Calculator on IRS.gov.
Those of you who receive Social Security benefits, unemployment compensation and certain other government payments can also choose to have federal tax taken out by filling out Form W-4V and giving it to their payer. Here too some restrictions apply.

For taxpayers whose income is normally not subject to withholding, starting or increasing withholding is not an option. Instead, they can avoid the estimated tax penalty by making quarterly estimated tax payments to the IRS.


In general, this includes investment income such as interest, dividends, rents, royalties and capital gains, alimony and self-employment income. Those involved in the sharing economy may also need to make these payments.

Estimated tax payments are normally due on April 15, June 15, Sept. 15 and Jan. 15 of the following year. Any time one of these deadlines falls on a weekend or holiday, taxpayers have until the next business day to make the payment. Thus, the next estimated tax payment for the fourth quarter of 2017 is due Tuesday, Jan. 16, 2018.

The fastest and easiest way to make estimated tax payments is to do so electronically using IRS Direct Pay or the Treasury Department’s Electronic Federal Tax Payment System (EFTPS).

For information on other payment options, visit IRS.gov/payments.

You may also use Form 1040-ES to figure these payments. IRS Publication 505, Tax Withholding and Estimated Tax, is a complete resource on withholding and estimated payments.

If you figure your payments using the regular installment method and later refigure your payments because of an increase in income, you may be charged a penalty for underpayment of estimated tax for the period(s) before you changed your payments.

If you do not receive your income evenly throughout the year (for example, your income from a repair shop you operate is much larger in the summer than it is during the rest of the year), your required estimated tax payment for one or more periods may be less than the amount figured using the regular installment method.

However, if your income is received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income and making unequal payments.

The penalty may also be waived if:

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

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.

As always, we recommend that you rely on professional advice to make sure you don’t underpay or overpay your taxes, estimated and otherwise.

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