Estimated Tax Penalties & Legal Obligations
Taxpayers may need to pay estimated tax on income from interest and dividends, self-employment, rent, and other types of income for which there is no automatic withholding. This requirement usually arises when a taxpayer expects to owe at least $1,000 in taxes once they have applied any withholding and refundable credits, and the taxpayer expects those credits to be less than 90 percent of the tax shown on their current tax return or the full amount of the tax shown on their previous tax return, whichever amount is smaller. In some cases, however, a taxpayer may be able to reduce or avoid paying estimated taxes if they ask for additional taxes to be withheld from their paychecks for a job that automatically withholds taxes.
Failing to pay estimated taxes as required can lead to severe penalties. As a result, it is important to avoid underpaying estimated taxes if possible. You can review Form 1040-ES to calculate the estimated taxes that you owe. If you earn less than $150,000 in a year, your estimated tax generally should equal the total tax that you paid in the previous year, while taking any withholding and refundable credits into account. If you earn more than $150,000 in a year, your estimated tax generally should amount to at least 110 percent of the total tax that you paid in the previous year, again taking withholding and refundable credits into account. If you can calculate your estimated income, you should try to pay at least 90 percent of the tax you will owe on that income, but many people find it difficult to calculate their income for the current year precisely.
Penalties for Underpayments
A penalty may be applied if you either make an inadequate payment of estimated taxes or make no payment when a payment was required. Penalties may apply even if you are entitled to receive a tax refund. The IRS usually will calculate any penalty for underpaying estimated taxes, but sometimes the taxpayer will need to calculate the penalty. The rate varies from year to year. Form 2210 contains two ways to calculate the penalty amount, which depends on the extent of the shortfall.
Certain exceptions may apply to negate penalties. First, a taxpayer whose total tax is less than $1,000 will not be subject to penalties. Also, a taxpayer who did not have any tax liability in the previous year will not be subject to penalties as long as they were a resident or citizen of the U.S. throughout that year.
Waiving Penalties
In addition to the exceptions discussed above, waivers of penalties may apply in some cases. The IRS may voluntarily decide to waive a penalty if imposing the penalty would be unfair or inequitable. This means that the taxpayer failed to pay adequate estimated taxes because they suffered a serious loss or disaster.
The IRS also may waive a penalty for failing to pay the required estimated taxes if a taxpayer retired after they turned 62 or became disabled during the current tax year or the previous year, had a good reason for failing to make the payment, and did not willfully neglect to pay it. You will need to request a waiver in these circumstances by submitting Form 2210. With the form, you should submit a statement to explain your reason for failing to make the appropriate payments. The statement should be supported by documents that show your eligibility for the waiver and the reason for your failure to pay. You should set a certain time period for the waiver.
