Estimated Tax Penalty

Based Upon the Original Tax Return

The estimated tax penalty is based upon the amount shown on the original or superseding return.

Reasonable Cause

The estimated tax penalty cannot be abated or removed due to reasonable cause alone.

IRS Penalty Relief due to a Disaster

It is rare that the IRS will abate the estimated tax penalty due to a disaster. However, if there is a federally declared disaster the secretary may provide for a period of up to one year where the failure to pay estimate tax penalty is waived by the IRS. Under these circumstances penalty relief should generally automatically occur. However, if a taxpayer needs relief because their tax professional or their books and records were located in a disaster area they should call the IRS at 1-866-562-5227 to request penalty relief.

Request for Abatement due to Erroneous Refund

If a taxpayer requests that his refund is applied to next year’s taxes, but instead the IRS issues a refund, any estimated tax penalty from the underpayment that was caused by an erroneous refund should be abated.

Assertion of Estimated Tax Penalties

Taxpayers who are required to make estimated quarterly payments are those that are not covered by withholding taxes. If a taxpayer makes payments at least equal to the required estimated tax payment in four equal installments then the taxpayer will not be assessed an estimated tax penalty.

If a taxpayer fails to pay the estimated tax payments, the IRS will assert a penalty against the taxpayer. Keep in mind that the taxpayer can use the annualized income or adjusted seasonal installment methods for computing estimated tax payments. Furthermore, there are alternative calculations available for short tax years. Contact our tax firm for assistance with calculating the annualized income or adjusted seasonal installment methods.

The IRS will not impose an estimated tax penalty if an individual,
a) incurred no tax liability during the previous taxable year, and
b) they were a citizen or resident of the United States throughout the preceding year, and
c) the preceding tax year was a 12 month period.

Determining the Required Annual Payment

Taxpayers must pay the lesser of 90% of the tax shown on the current years return or the specified percentage of the taxpayer’s preceding years return. If the taxpayer earned income in the preceding tax year of $150,000 or less then the taxpayer’s specified percentage is 100%. If in the preceding tax year the taxpayer earned more than $150,000, then the taxpayer is required to pay 110%.

Special Rules for Small Business Owners
Starting in 2009, an owner of a small business whose adjusted gross income is less than $500,000 and half of which is from business, is only required to pay 90% of the previous year’s tax liability in estimated tax payments.

Limitation on using previous year’s tax

A taxpayer is not allowed to use the previous year’s tax if the taxpayer did not file a return, but was required to do so, or the preceding year was less than 12 months.

Changes in Filing Status

Taxpayers who filed separately in the previous year and in the current year will file jointly, should add the two taxpayers returns from the previous year to determine their specified percentage.

Short Taxable Year Following a 12 Month Year

Taxpayers who this year will file for a short tax year--and who last year filed for a full 12 months--are entitled to divide the prior year’s tax by 12, and multiply the result by the number of months in the short tax year.

Non-Resident Aliens

For purposes of estimated taxes, a non-resident alien is an individual who is (1) not a U.S. citizen, (2) is not a resident of the United States, and (3) whose wages are not subject to federal withholding.

A non-resident alien is required to make three annual installments each year instead of four. The first annual installment is 50% of the amount required while the second and third are each 25%. In the case of a calendar year taxpayer the due dates are June 15, September 15, and January 15 of the following year.

Deceased Taxpayers

An underpayment penalty of estimated taxes is only asserted against installments that were due before the date of death. If taxpayers are filing jointly, then it is only the latter date of death that stops the underpayment penalty of estimated taxes.

Fiduciaries of Estates and Trusts

All estates and most trusts are required to pay estimated taxes in the same manner as individuals. As a general rule, estates and trusts are only required to pay estimated taxes if they owe more than $1,000.

A fiduciary may elect to treat any portion of an estimated tax payment as a payment made by a beneficiary. This election must be filed before the 65th day after the close of the taxable year on Form 1041-T.

Annualized Income Installment Method

Taxpayers who do not receive income evenly throughout the tax year may choose to calculate their estimated tax payments by using the annualized income installment method. This method allows taxpayers to make payments that reflect income during each period in the year, rather than ratably throughout the entire year.

Farmers and Fisherman

Individuals who receive two thirds of their gross income from farming or fishing are allowed to pay their estimated taxes by January 15th following the close of the tax year if they are a calendar year taxpayer, or March 1st if their return is filed and taxes are paid on or before that date.

For qualifying farmers and fisherman they are required to pay 2/3rds of the current year’s tax or 100% of the total tax shown on the prior year’s return. If a farmer or fisherman files a joint return, the spouse’s income must be considered when determining what percentage of income comes from farming or fishing.

Short Taxable Years
Individuals may file a short period return if they change their accounting period or method. Furthermore, a short period return may be filed if the individual goes into bankruptcy. If an individual passes away during a tax year their return is not considered a short tax period, but rather a full 12 month period (special rules do apply).

Taxpayers who file a short taxable year return are in general still required to make estimated tax payments. However, some of the payments may not be due depending on the method used for calculating estimated tax payments and the dates of the short tax year.

Period(s) of Underpayment

If a taxpayer fails to pay the required estimated tax, an underpayment exists. This underpayment begins to accrue on the date the installment is due until it is paid, or the 15th day of the 4th month following the end of the taxable year. Timely mailing equals timely paying.

Withholding Credits

Credits the IRS receives from withholding are applied evenly throughout the year. However, if a taxpayer wishes they can credit the withholding in the period in which it was withheld. In order to credit the withholding in the correct period Form 2210 (or 2220) must be filed with the return.

Estimated Tax Penalty Rate

The estimated tax penalty is computed the same way as interest, except that it is not compounded daily. Therefore, the same rate that applies for interest applies with the estimated tax penalty. The penalty rate is described in IRC §6621. The rate is also available in IRS Notice 746.

Waiver Based on Change in the Law

Sometimes a law changes with retroactive tax consequences, thereby causing a taxpayer to get assessed an estimated tax penalty. Usually the law provides that estimated tax penalties may be waived to the extent the penalty is a direct result from changes in the law.

Waiver Based upon Casualty, Disaster or Other Unusual Circumstances that Would be Against Equity

This waiver may sound like it is similar to reasonable cause, but it is not. This waiver cannot be used if the taxpayer relied on a tax advisor, but things still went wrong. An acceptable circumstance would be that the taxpayer requested that an overpayment shown on a prior year's return get credited against estimated taxes, but the overpayment was offset to either settle past-due child support or non-tax federal debt.

Waiver Criteria Under IRC Section 6654(e)(3)(B)

If a taxpayer either reaches the age of 62, or becomes disabled, then he/she is entitled to penalty relief if they can show reasonable cause and not willful neglect. The typical rule regarding estimated tax penalties is that reasonable cause does not excuse the failure to comply with the laws.

Determining the Required Payment Amount

Corporations, non-profits with unrelated business income, or private foundations with certain excise tax or investment income are required to pay the lesser of 100% of the current year’s tax, or 100% of the prior year’s.

Exception: If the prior year’s tax was zero, or based upon less than a full 12 months, then the taxpayer cannot use 100% of last year’s tax.

Small Amount of Tax

A Corporation is not required to pay estimated taxes if the tax amount shown on the return is less than $500.

Short Tax Year

A corporation is required to file a Form 2220, and supporting worksheet, even if all its income is earned in the last month of the fiscal year, so long as the $500 threshold is met.

If a taxpayer filing for a short period wishes to use tax from the prior year to determine the required annual payment, the taxpayer must adjust the amount by dividing by 12 and multiplying by the number of months in the short tax year.

Domestic Corporations

A domestic corporation is required to make installments based on the amount of tax imposed minus any allowable credits.

Recapture Tax

Any recapture of LIFO benefits is not to be included in the estimated tax penalty calculation.

Foreign Corporations

A foreign corporation that has effectively connected business income is subject to estimated tax payments on this amount in the same manner as a domestic corporation.

If the foreign corporation also has income described in IRC §881 then it must include the taxable amount under IRC §881 in calculating estimated tax payments.

Tax Exempt Organizations

A tax exempt organization that has unrelated business income, or net investment income, must provide estimated tax payments based on those amounts.

Large Corporations

A large corporation is one that had taxable income of one million dollars or more during any of the three years preceding the tax year. Large corporations are required to pay 100% of the current year's tax liability in estimated tax payments.

1) A large corporation may use 100% of the prior year's tax liability to determine the required estimated payment only for the first installment of any tax year.

2) If a large corporation makes a first installment based on the above paragraph, then in the second installment the large corporation must add the difference to what would have been required if the amount is greater.

A large corporation must file Form 2220 and check the box indicating that it is a large corporation.

Tax Withheld by Partnerships Under IRC §1446

Partnerships with foreign partners are required to withhold tax on all effectively connected taxable income allocable to the foreign partners. The partnership reports the amount withheld on Form 8804. The amount due is essentially paid in the same way for domestic corporations, except as modified by Treas. Reg. §1.1446-3.

Equal Installments

Unless the taxpayer elects to use the annualized income or seasonal method to determine its required payments, the taxpayer must pay the total annual payment in equal installments.

Annualized or Adjusted Seasons Method of Determining the Payment

If a corporation is able to demonstrate that its payments would be lower if it used the annualized or adjusted seasonal method of calculating required payments, it can use the method which provides the lowest payments. Furthermore, the corporation can elect to use different annualization periods by filing Form 8842.

If a corporation reduces its installment by annualizing its income and then switches to another method, it must recapture 100 percent of any prior reduction in the next installment.

Period of Underpayment

For corporations, the underpayment period is determined by the number of days from the payment due date until the earlier of the date the payment is received or the due date of the return.

Excessive Adjustment

A corporation can request a quick refund of an overpayment of estimated taxes by filing Form 4466. If a corporation files Form 4466 and the adjustment requested on Form 4466 was excessive, the code calls for an additional penalty.

Payment Due Dates

Generally, the payment due dates are the 15th day of the 4th, 6th, 9th, and 12th month of the taxable year.

Application of Estimated Tax Payments and Credits

The payments and credits are applied to the liability in the order in which the liabilities arose.

Determining the Amount of the Underpayment

The amount of the underpayment is the required amount reduced by the amount of credit or payments made by the due date. If the due date falls on a weekend or holiday, the payment is considered made on the due date if it was made on the first business day after the weekend or holiday.

Determining the Estimated Tax Penalty Amount

For each installment the penalty amount is determined by multiplying the amount of the underpayment, by the number of days the payment is late, by the applicable percentage. This calculation is based on the original or superseding return.

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Disclaimer: Teogathalaw Law does not guarantee the accuracy of the material contained on this website, or webpage. None of the material presented on this website concerning tax matters may be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the taxing authorities.

Page last revised : November 14, 2011