Avoiding tax underpayment due to unexpected stock capital gains

[letha-m-joy]

I earned more than expected capital gains from stock sale this year and I am wondering whether I have done considerably lower tax withholding this year. I also wonder whether I will have to pay penalty for tax under payment  when I file taxes in April 2015. Is there a way to avoid this IRS penalty by paying estimated tax payments before the year end?

[letha-m-joy]

I have a follow up question. Is the penalty waived if there was no tax liability in the prior year (i.e. if you got a refund) ?

[dmertz · Accepted solution]

Most dividend and capital-gains distributions occur at year-end, so making a sufficient 4th quarter estimated payment by the January 15 deadline will eliminate the possibility of a penalty that might otherwise result from these year-end distributions.  In other words, make a 4th quarter estimated payment sufficient to cover your overall tax liaibility when combined with your other tax withholding and estimated payments.  However, you might need to annualize income on Form 2210 to avoid an underpayment penalty for the earlier quarters of the year.  (You could still end up with underpayment penalties for the first three quarters of the year if your other tax payments were insufficient to cover the income in these quarters.)

Even if you don't have enough withheld or paid in estimates to cover your tax liability, if you meet any of the safe-harbors (see TomYoung's comment below) you won't have an underpayment penalty.  Regarding underpayment penalties, see:  http://www.irs.gov/taxtopics/tc306.html

[TomYoung]

That's a miss statement of the safe harbor provisions.  There are 3 basic safe harbors but the relevant ones here that allow you to avoid underpayment penalties are paying the lesser of
     a)90% of the tax for the current year, or
     b)100% of the tax shown on the return for the prior year.  (If last year's return shows AGI over $150K (for married filing jointly) then change that "100%" figure to "110%.)

[dmertz]

Thanks Tom, I've changed my answer to refer to your comment.

[VolvoGirl]

Some more info......
You might be able to eliminate it or at least reduce it.  You can go to Federal Taxes tab or Personal tab, under Other Tax Situations and select Start by the Underpayment Penalties. You will answer a series of questions that may reduce or eliminate the penalty. Or you can elect to have the IRS figure the penalty for you.  It's form 2210.

It's under
Federal Taxes or Personal (for H&B version)
Other Tax Situations
Additional Tax Payments
Underpayment Penalties - Click the Start or update button

If you have the desktop program you can switch to Forms Mode (click forms in the upper right (left for Mac)) and open the 2210 form.

[letha-m-joy]

I have a follow up question. Is the penalty waived if there was no tax liability in the prior year (i.e. if you got a refund prior year) ?

[TomYoung]

No.  "The tax" has a different meaning here.  It's essentially the total of all your taxes less any refundable credits.  More or less it's your tax BEFORE any credits for withholding or estimated taxes paid.

[nrmitchell]

Hi Tom.  Your posting would seem to be applicable to the situation I am currently in, needing to be 110% of my 2014 tax bill for 'safe harbor' and avoid April 2016 tax filing penalties, following an unexpected capital gain.  Do you happen to know which IRS form (and also that of New York state) I need to complete please?  Many thanks

[fuyunling]

@dmertz 

I am in the same boat this year (for 2024 tax return!).  Most of my capital gain distributions are in the fourth quarter.  It is also true for dividends although in a less degree.   I just want to make sure that in form 2210, I should report the dividends and capital gain distributions in the months, in which they are distributed.  For example, if a dividend is distributed in May, it should be included in the AGI of the second period (April-May).  Maybe this is obvious, but because it is first time that I use the AI schedule of 2210, I just want to make sure.

Thanks in advance for your help!

[dmertz]

@fuyunling , yes, that is the way I would do it (and have done it myself).

[fuyunling]

Thank you very much for your confirmation!