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1040-SR Line 38 Tax Penalty Surprise

I have never owed as much as I do this year because of capital gains in my broker account. The market is unpredictable, and I was surprised by the increase, which can easily be the opposite in 2025. Does anyone have ideas on how to protest this penalty? Thanks!

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3 Replies

1040-SR Line 38 Tax Penalty Surprise

We feel your pain. As a person filing his own taxes for approximately 20 years, and a close observer of my tax returns for several decades before that, I've seen capital gains rates and overall tax rates fluctuate. But overall they are lower on long-term gains than ever before in my long experience. But not so low for short-term gains. If you are an active trader, I expect much of your gains were short term. On that, my only immediate advise is to take a close look at and consider  the length you have to hold investments before you can claim the longer-term (lower) capital gains rates before selling an investment.

 

On the moral support side, consider that, as you say, markets go up and down, and using this year so far as example only, if you bought an investement late last year and sell now, you would probably have a capital gains loss for next year's tax purposes, which should reduce your taxes owned, assuming you have other taxable income, a year from now.

 

Finally, I remember income averaging, which reduced the tax load for people getting a one-year only exceptional income boost. That provision went away. Speak to your congresspeople, Senator's offices to express your views on bringing that back. They might tell you overall rates are lower than they were in the days of income averaging, and that is true; but still, for more average tax payers, income averaging would surely help more for those who sell their sole long time residence and have big capital gains on that. Maybe not so helpful as lower overall tax rates for those taxpayers who have multiple residences, major ongoing investment or income generating holdings, so have a large income almost every year. Hmm.

Vanessa A
Employee Tax Expert

1040-SR Line 38 Tax Penalty Surprise

The estimated tax penalty is a penalty for not paying your taxes in full throughout the year. If you are seeing a penalty, you can go back into the program under Other Tax Situations>>Additional Tax Payments>>Underpayment penalties and select start or update next to Underpayment Penalties. These questions are meant to help you apply for the exemption to the penalties.

 

Some exceptions to the penalty are 

  • You had $0 tax liability in 2023
  • You paid 100% of your 2023 tax liability (110% if your income is over $150,000 or $75,000 if MFS)
  • You paid 90% of your 2024 tax liability 
  • You or your spouse (if you file a joint return) retired in the past 2 years after reaching age 62 or became disabled and you had reasonable cause to underpay or pay your estimated tax late

 

You will find this under 

  1. Other Tax Situations
  2. Additional Tax Payments
  3. Underpayment penalties 

Also, when you get towards the end of the return, you should be asked by TurboTax if you want to apply for the penalty waiver.  

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1040-SR Line 38 Tax Penalty Surprise

have you gone thru the section in Other Tax Situations / Underpayment Penalty to make sure TT has your 2023 info and the safe harbor penalty calcs on Form 2210 are correct.  You may also be able to reduce the penalty if you adopt the Annualized Income method depending on your situation.

 

Did you pay any estimated tax (ES) last year either regularly or specifically for this cap gain event?  When you have a large unexpected income event such as Roth conversion or large cap gain you can pay one-off ES and then use Form 2210 Annualized Income method to show the timing, otherwise you will get penalized because the calcs assume by default your total income was earned evenly thru the year and your estimated taxes need to match (withholding is also assumed to be paid evenly thru the year, it's just ES which come with specific dates) and the penalty is calculated quarterly - if you took the cap gain later in the year and don't adopt the AI method it will assume a quarter of that gain was in Q1 and penalize you since then etc.

 

The "safe harbor" to avoid penalty is to have paid "timely" during the year via withholding or quarterly ES either 100% of 2023 tax (110% if AGI > 150k) or 90% of 2024 tax, whichever is smaller.  If you didn't hit either of those you will certainly have a penalty.

 

The other issue you may now see is TT by default will generate ES vouchers for 2025 based on paying "100/110% of 2024 tax" in 2025 thru withholding or estimated taxes, which may now be too high if 2024 had some one-off high income.  You can go through Other Tax Situations / Form W4 and Estimated Taxes to provide estimates for 2025 to see if you can then adopt "90% of 2025 tax" instead, and determine if any withholding is enough or you need to pay ES.

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