How does Turbotax Calculate Penalty for underpayment of taxes

[Cinna13604]

Background: 

A. In 2023 I was working and retired in the middle of the year with a severance package. Let's say that year total income was 100k. Total taxes I owed was approximately: $28k.

B. In 2024, I only had investment income  such that: 5k for the first three quarters and 10k for the 4th quarter. 

C. In 2024, I had been making estimated tax payments for each of the quarter - $850 (17% of 5k) for the first three quarters and for the last quarter I used TurboTax itself to do a mock tax prep and ensured at least 90% of the total tax for 2024 was met. (In fact I paid lot more than 90%).

D. After all these, when I prepared my final tax return, Turbo Tax (2024 tax year, which comes out in late 2024/early 2025), calculated a penalty.  

The irony is, the final tax return, per Turbo Tax showed both a refund AND it also showed a penalty.

Here are my questions:

a. How does Turbotax calculate the penalty? Is it per quarter but based on the total AGI/MAGI/total taxable income for the whole year? 

b. How do you explain a refund and a penalty for the same tax year?

c. In general if the total tax payments for a tax year is $5000 (which comes to $1250 per quarter), but I made estimated tax payments of $850 for the first three quarters and $2600 for the fourth quarter, do you still calculate a penalty because at a quarter level, for the first three quarters, I would have underpaid?

d. Is this the way IRS determines the penalty?

Thanks in advance for your reply.

[baldietax]

TT uses Form 2210 to calculate the penalty.  If you are on desktop go to Forms mode to the penalty line on 1040, double-click it to the 1040 worksheet and double-click it again to bring up Form 2210 which will show the minimum safe harbor amount and penalty calculation.  I am not as familiar with TT Online but this form may be in the PDF with "All forms and worksheets"

The issue you are finding is the penalty is determined quarterly so you could meet the safe harbor amount (100% of 2024 or 90% of 2025 whichever smaller etc) - or even overpay and have a refund - but on a quarterly basis if you paid estimated tax unevenly it could generate a penalty for the quarters earlier in the year (with 8% penalty rate).  The assumption is the tax you owe is earned evenly thru the year, and that safe harbor total amount is divided by 4 into quarters, and if your estimated tax doesn't line up with that either in amounts or payment dates (generally referred to the IRS as "timely"), it will generate a penalty.

If you paid unevenly due to the fact the income was uneven e.g. you had an unplanned Roth conversion or large cap gain event late in the year, then you can adopt the Form 2210 "Annualized Income" method to show your AGI etc by quarter to line up with the estimated taxes.  You have to provide cumulative AGI, Cap Gains, Qualified Divs etc for 3/31, 5/31, 8/31.  Maybe similar for state.  This can be a lot of work and may not entirely eliminate your penalty.  In TT you can go thru this process in "Other Tax Situations" under Underpayment Penalty section.

For 2025 planning under "Other Tax Situations" "Form W4 and Estimated Taxes" you can provide 2025 estimates for your income to determine whether to use the 100% of 2024 or 90% of 2025 to pay estimated taxes.  Unless your 2024 income was unusually high for some reason then the simplest approach is to pay 100% of 2024 in even estimated tax payments since everything is known and you should not get a penalty even if you have some large unplanned income event at any point in 2025.

More on Estimated Taxes here https://www.irs.gov/faqs/estimated-tax

Form 2210 instructions here https://www.irs.gov/pub/irs-pdf/i2210.pdf

Not a CPA/Expert just my 2 cents having gone thru the AI process for 2024 and keen to avoid doing it again - hope this helps.

[MonikaK1]

Paying all of your tax prior to the due date of the tax return will ensure that you avoid interest for late payment. However, depending on when you made your tax payments, you could still be subject to the underpayment of estimated tax penalty (Form 2210).

For most filers, if your federal tax withholdings and timely payments are not equal to 90% of your current year tax, or 100% of the total tax from the prior year (whichever is less), then you may need to complete Form 2210 to determine if you are required to pay an underpayment penalty.

If your current year total tax (not just the amount due with the return) minus the amount of tax you paid through withholding is less than $1,000, you are not required to pay the underpayment penalty and do not need to complete Form 2210.

It may help in some situations to go through the Underpayment Penalty section of TurboTax and answer the interview questions. The program will calculate a penalty automatically based on just the amounts and dates paid and the amount of tax due, but the penalty may be reduced depending on the answers to the questions.

See this TurboTax tips article for more information about Form 2210.

If TurboTax is showing an underpayment penalty on your return, visit or revisit the Underpayment Penalty section under Other Tax Situations and answer the interview questions. The penalty calculation may change based on your answers, including information about when your withholding was applied. In addition, if you believe you qualify for a waiver of the penalty, you can request a waiver in that section.

The IRS may reduce an underpayment penalty if any of the following apply:

• 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. See Waiver of Penalty in Instructions for Form 2210PDF.
• You had most of your income tax withheld early in the year instead of spreading it equally through the year. 
• Your income varies during the year. Complete Form 2210, Schedule AI, Annualized Income Installment Method PDF(found within the form).

The penalty for underpayment of estimated tax can also be removed to the extent that the underpayment is the result of a casualty, local disaster, or other unusual circumstance such that it would not be fair to impose the penalty.

See here for information about different TurboTax tools you can use to calculate withholding and estimated taxes

@Cinna13604