You can be subject to penalties if you don’t pay enough tax during the year through estimated tax payments and withholding. Here are some strategies to help avoid underpayment penalties:
Know the minimum payment rules. For you to avoid penalties, your estimated payments and withholding must equal at least 90% of your tax liability for the year or 110% of your tax for the previous year (100% if your AGI for the previous year was $150,000 or less or, if married filing separately, $75,000 or less). Warning: Watch out for underwithholding. See “What’s new! Underwithholding may still be a risk.”
Use the annualized income installment method. This method often benefits taxpayers who have large variability in income by month due to bonuses, investment gains and losses, or seasonal income (especially if it’s skewed toward the end of the year). Annualizing computes the tax due based on income, gains, losses and deductions through each estimated tax period.
Estimate your tax liability and increase withholding. If as year end approaches you determine you’ve underpaid, consider having the tax shortfall withheld from your salary or year end bonus by December 31. Because withholding is considered to have been paid ratably throughout the year, this is often a better strategy than making up the difference with an increased quarterly tax payment, which may still leave you exposed to penalties for earlier quarters.
Warning: You also could incur interest and penalties if you’re subject to the additional 0.9% Medicare tax and it isn’t withheld from your pay and you don’t make sufficient estimated tax payments.
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