Have you switched jobs in the past year? Did you start a business? Do you own interest in a pass-through entity? Did you reduce your withholding? These are all scenarios that could result in underpayment penalties come next April. The penalty is avoidable if any of the following tests are met. They are:
1. Small Balance Due. If after deducting your withholding from your total tax you owe less than $1,000 then there is no penalty applied.
2. No Prior-year Tax. If you had no prior year tax liability and was a U.S. citizen or resident for the entire year then no penalty would apply for the next year.
3. Exception 1 – Using Prior Year Tax. If you paid through withholding and timely estimates 100% of your prior year tax then no penalty will be assessed. If your AGI for the prior year was greater than $150,000 then 110% of your prior year tax must be paid in.
4. Exception 2 – 90% of Current Year Tax. If you paid through withholding and timely estimates 90% of your total current year tax then no penalties will be assessed.
5. Exception 3 – Annualized Method. If you paid through withholding and timely estimates 90% of your current year tax. The total income for the year is broken down by year-to-date for each quarter and applied to estimates.
All of these tests can be applied to a taxpayer and the one with the smallest penalty can be used. These tests can also be used for planning. If you know of a particular change in your income for the coming year and wish to owe little or no tax in April we can base estimates on that information. The estimates and penalties are also based on quarterly due dates. If your tax situation has changed since the prior year we can prepare estimates for the remainder of the year that will reduce your penalties.