In the U.S., federal income taxes are a "pay-as-you-go" system, meaning you're required to pay taxes as you earn income throughout the year by having them withheld from your paycheck or by making estimated tax payments. Pay too little, and you may need to file a special form, Form 2210, with your tax return.
• For most filers, if your federal tax withholdings and timely payments are not equal to 90% of your current year tax, or 100% of the total tax from the prior year (whichever is less), then you may need to complete Form 2210 to determine if you are required to pay an underpayment penalty.
• If your current year total tax minus the amount of tax you paid through withholding is less than $1,000, you are not required to pay the underpayment penalty and do not need to complete Form 2210.
• Different rules apply if at least two-thirds of your income is from farming or fishing.
• If your adjusted gross income is greater than $150,000 (or $75,000 if you're married filing separately), you can typically avoid a penalty by timely paying at least 110% of your tax from the prior year.
Use Form 2210 to determine the amount of underpaid estimated tax and resulting penalties as well as for requesting a waiver of the penalties. You may need this form if:
- You're self-employed or have other income that isn't subject to withholding, such as investment income.
- You don't make estimated tax payments or paid too little.
- You don't have enough taxes withheld from your paycheck.
What is the IRS underpayment penalty?
The IRS can charge a tax penalty for failure to pay the proper estimated taxes throughout the year.
The IRS calculates this penalty by first figuring out how much you should have paid each quarter. Then, it multiplies the difference between what you paid and what you should have paid by the underpayment rate for that period. The IRS determines that rate for each quarter of the year.
For 2023, the rates are:
- 7% for Quarter 1 (January-March), 7% for Quarter 2 (April-June), 7% for Quarter 3 (July-September), and 8% for Quarter 4 (October-December)
For example, if you owed $20,000 in taxes during the first quarter of 2023, then you should have paid $5,000 per quarter. In the first quarter, you paid only $4,000. Your underpayment penalty for that quarter would be $17.50 ($5,000 - $4,000 = $1,000 x 7%/4 (a quarter)).
Avoiding the underpayment penalty?
You can avoid the penalty if your total timely estimated payments and withholdings are greater than or equal to the lesser of:
- 90% of the total tax after credits for the current year, or
- 100% of the total tax after credits in the prior year
You can also avoid the penalty if the amount you owe is less than $1,000 as long as any estimated tax payments payments you made are timely.
Certain taxpayers have special rules for determining when they might owe an underpayment penalty:
- Farmers and fishers. If at least two-thirds of your income is from farming or fishing, you can avoid an underpayment penalty by paying at least 66.6% of the tax you owe for the current year by the estimated tax due date in January (usually January 15) of the following year, or if you file your tax return and pay all the tax you owe by March 1 of the following year.
- High-income taxpayers. If your adjusted gross income (line 11 of your 2023 Form 1040) is greater than $150,000 (or $75,000 if you're married and file a separate return from your spouse), you can avoid a penalty by paying at least 110% of your total tax from the prior year.
- Household employers. If you file Schedule H with your tax return to report wages paid to a household employee, you're not required to include household employment taxes in your penalty calculation if:
- You didn't have federal income taxes withheld from wages, pensions, annuities, gambling winnings, or other income, and
- You wouldn't be required to make estimated tax payments to avoid a penalty even if you didn't include household employment taxes in your estimated tax calculation.
As long as you use one of these methods for calculating and paying your estimated tax payments or withholding, you can typically avoid a penalty. Just keep in mind, if you underpay the final amount of tax due, you'll have to pay the difference when you file your tax return.
TurboTax Tip: If you experienced an unusual event that prevents you from making estimated payments, you might qualify for an underpayment penalty waiver. Examples of qualifying circumstances include a grievous illness, damage to your home in a disaster, or fleeing domestic violence.
Who must file Form 2210?
Form 2210 can be used as a worksheet and doesn't need to be filed with your tax return in many cases. It can be used to determine if there is a penalty and you may be able to leave Form 2210 off your return and have the IRS calculate your penalty and send you a bill if there is one.
The top of the form includes a flowchart to help taxpayers decide who must file the form. If you fall into one of the following categories, you're required to figure out the penalty yourself and attach Form 2210 to your tax return:
Those requesting a waiver for part of their penalty
In addition to the rules mentioned above, there are a few other ways to have your underpayment penalty waived:
- Age 62 or older and retired or disabled. If you're age 62 or older and retired or disabled, you can ask to have your penalty waived for reasonable cause. Reasonable cause includes financial hardship or losing your physical or mental control over your faculties.
- Circumstances beyond your control. If you experienced an unusual event that prevents you from making estimated payments, you might qualify for an underpayment penalty waiver. Examples of qualifying circumstances include a grievous illness, damage to your home in a disaster, or fleeing domestic violence.
- Federally declared disaster. If you live in a federally declared disaster area, you qualify for an automatic underpayment penalty waiver.
If you're requesting a penalty waiver due to any of the above situations, enter the amount you want to be waived in parentheses on the dotted line next to line 19 (tax year 2023 form). Subtract this amount from your total penalty and enter the result on line 19.
Then, attach a statement to your tax return explaining why you were unable to make the required estimated payments. You may also need to attach documentation, such as proof of retirement, disability, illness, or damage to your home.
Those who use the annualized income installment method
Some individuals and businesses don't receive income evenly throughout the year. For example, if you own a pool service business, the bulk of your income likely comes during the summer months. Owners of these types of businesses have the option of using the annualized income installment method to calculate their estimated quarterly tax payments.
This method allows you to estimate your tax for each quarter based on your income and deductions rather than paying four equal installments.
If you elect to use this method, you must include Form 2210 with your tax return.
How to avoid an IRS underpayment penalty in future years
If you were caught off guard by an IRS penalty, use the following steps to help you avoid or reduce underpayment penalties in the future:
- Adjust your withholding. If your employer isn't withholding enough tax from your pay, you can submit a new Form W-4 to have them withhold more. You can use TurboTax's W-4 Withholding Calculator to help you estimate the right withholding amount and fill out the form.
- Make estimated payments. If you have significant income that isn't subject to withholding, such as self-employment earnings, you may need to make estimated tax payments. Quickbooks Self-Employed can help you track your income and expenses, estimate your quarterly taxes, and even electronically send quarterly tax payments to the IRS.
- Annualize your income. If your business is prone to income fluctuations, consider using the annualized installment method to calculate your estimated payments or reduce your underpayment penalty. TurboTax Premium can guide you through using this method when you prepare your tax return.
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