How to Avoid Tax Underpayment Penalties

In order to avoid tax underpayment penalties, you have to pay in the appropriate amounts to cover your tax liability throughout the year. You're subject to penalties if you don't withhold enough taxes on wages received or other forms of income subject to withholding. You need to calculate your estimated quarterly tax liability and either adjust your withholding accordingly or make quarterly tax payments to avoid a penalty.

Instructions

Difficulty: Moderate

1. Compute your estimated gross income for the current year taking into account any expected changes in your income. You can use the prior year amounts as a starting point and then make adjustments as warranted.
2. Deduct your estimated deductions and your exemption amounts to arrive at estimated taxable income. Review any tax deduction and exemption changes for the current year on the Internal Revenue Service website.
3. Use Form1040ES to determine the total estimated tax liability for the year. Compute the tax using the revised tax tables or tax schedules for the current year.
4. Subtract allowable tax credits such as the child tax credit and add other taxes such as self-employment tax to arrive at the net total estimated tax. Divide the total estimated tax by four to determine the estimated quarterly tax liability.
5. Estimate your annual tax withholding from wages and other income sources which are subject to withholding and divide that amount into four quarters. The quarterly amount must be equal to or more than the quarterly estimated tax liability.
6. Compute the safe haven where no penalty will be applied if your current year tax withholding equals or exceeds the tax shown on your prior year tax return (i.e., 110 percent of the prior year tax if your prior year gross income exceeded $150,000) or exceeds 90 percent of your estimated tax for the current year.
7. Ask your employer to increase withholding or make quarterly tax payment if the tax withholding is less than the estimated quarterly liability and not within the safe haven. You do not have to make estimated tax payments if the amount due is less than $1,000 for the year.

Tips & Warnings

• Even if you are due a refund when you file your current year return, you may be charged a penalty if there is a tax underpayment in any quarter.

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