I would like someone to confirm that I am interpreting this rule correctly.
One of the caveats the IRS lays out for avoiding the underpayment penalty is meeting 100 / 110% of the prior years tax liability.
A logical consequence of this would be that somebody having a tax liability of $0 one year and 100 million the next year would not be subject to an underpayment penalty if they chose not to pay any estimated taxes on the 100 million.
Is this correct? Am I missing something?
Yes, that is correct. However, don't confuse tax due with your return with tax liability for the year. If you had tax liability of $100,000, but only had to pay $50 with your refund, you would still need to pay at least $100,000 to avoid penalty for the following year.
If you simply didn't work in 2020, then became a multi millionaire in 2021, then you would meet the criteria of having no tax liability for 2020 and not having to pay anything to avoid the penalty on your millions in 2021.
You are correct. Exceptions to the Penalty
Hi Diane,
Thanks for the response.
You are using a different exception to confirm my hypothetical scenario.
I am talking about specifically the "100 / 110%" exception. The reason I'm making this distinction is the 100 / 110% exception also suggests that someone with a tax liability of something miniscule, say $50, one year and 100 million the next year would only have to pay $50/55 in estimated taxes to avoid the penalty if they chose not to pay any estimated taxes on the 100 mil. (Whereas your exception would not imply this).
Can you confirm?
Yes, that is correct. However, don't confuse tax due with your return with tax liability for the year. If you had tax liability of $100,000, but only had to pay $50 with your refund, you would still need to pay at least $100,000 to avoid penalty for the following year.
If you simply didn't work in 2020, then became a multi millionaire in 2021, then you would meet the criteria of having no tax liability for 2020 and not having to pay anything to avoid the penalty on your millions in 2021.
Vanessa,
Thank you.
On the image below, would you mind pointing out which line item represents the true "tax liability" that you're talking about.
Tentative Tax plus Additional Taxes from last year's return = would be your prior year tax liability.
Total Tax from last year's return = would be your prior year tax liability. The IRS safe harbor rule (110% of prior years Total tax liability) is there to allow for an individual taxpayer that has no idea what their total tax liability will be until the end of the tax year to just pay estimated taxes in the current year to equal 110% of the prior year total tax liability. It is a kind of loop hole to avoid the interest penalty, but the taxpayer still owes the balance of tax liability of the current year above the estimated taxes paid.