Avoid Estimated Tax Penalty with Increased Withholding

Taxpayers clearly aren’t paying enough attention to estimated tax penalties. A recent IRS Fact Sheet reveals that the number of people paying such penalties jumped nearly 40% from 7.2 million in 2010 to 10 million in 2015. In particular, individuals with substantial income in addition to salaries may find that the amount of tax withheld from their salaries isn’t enough to cover their required estimated tax payments. This may be the result of miscalculation or forgotten surprises—for example, a windfall on the sale of a capital asset earlier in the year, or unexpected exposure to the 3.8% surtax on net investment income. Also, an adjustment to withholding or estimated tax may be warranted by the additional Medicare tax. As this article explains, increased withholding, even at this relatively late time of the year, as well as a creative workaround, may stave off an estimated tax penalty. 

Estimated tax basics.

 An individual must make four quarterly installment payments of estimated tax based on the amount of his or her “required annual payment” to avoid an underpayment penalty. (Code Sec. 6654) In general, the required annual payment is the lesser of 90% of the tax shown on the current year’s return, or 100% of the tax shown on the previous year’s return. (Code Sec. 6654(d)(1)(B)) However, if an individual’s previous year’s return showed adjusted gross income exceeding $150,000 ($75,000 for marrieds filing separately), the required annual payment is the lower of 90% of the tax shown on the current year’s return, or 110% of the tax shown on the previous year’s return. (Code Sec. 6654(d)(1)(C)) Alternatively, a taxpayer may use an annualized income method to determine the required installments of tax if annualization results in lower quarterly payments. (Code Sec. 6654(d)(2))

The applicable test is applied separately to each installment. Thus, a taxpayer may be penalized for the underpayment of estimated taxes for any installment for which estimated tax payments made plus taxes withheld from the taxpayer’s salary (and from certain other payments such as pensions and annuities) don’t total at least 25% of his or her required annual payment.

Exceptions and waivers. The underpayment penalty doesn’t apply:


  1. If the tax shown on the return (or the tax due, if no return is filed) is less than $1,000 after reduction for federal income tax withheld (Code Sec. 6654(e)(1)), or
  2. If the individual was a U.S. citizen or resident for the entire preceding tax year, he or she had no tax liability for that year, and that year was a 12-month year (Code Sec. 6654(e)(2)) or
  3. For the 4th installment, if the individual (who is not a farmer or fisherman) files his or her return by the end of the first month after the tax year (Jan. 31 for calendar year taxpayers), and pays in full the tax computed on the return (Code Sec. 6654(h)), or
  4. In certain cases while a Title 11 bankruptcy case is pending. (Code Sec. 6658(a)) and check the Chapter 7 Bankruptcty Lawyers for your financing management.

The underpayment penalty may be waived by IRS if:


  • Failure to pay was due to casualty, disaster, or other unusual circumstances where imposing a penalty would be inequitable or against good conscience (Code Sec. 6654(e)(3)(A)) or
  • Underpayment was due to reasonable cause (not willful neglect), and the taxpayer retired (after reaching age 62) or became disabled during the year for which the payments in question were required or in the preceding tax year. (Code Sec. 6654(e)(3)(B))