Underpayment penalty

[Stevehofwa]

This is never a clear subject.  Let’s say I have a job, with the usual withholding, and in May have sell a bunch of stock and incur capital gains.  So if I pay 110%(agi higher than 150k) of last years taxes or 90% of this years sometime during the year am I safe?  Some of the gains are offset by losses from the previous year, so the gain is less than initially reported to the irs.  Can I just increase withholding for the rest of the year, or if I’m in the safe harbor region can I wait until April 15th.  Don’t want to make a big payment earlier than I have to.

[rjs]

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@Stevehofwa wrote:

So if I pay 110%(agi higher than 150k) of last years taxes or 90% of this years sometime during the year am I safe?

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CORRECTED ANSWER

Yes, you are safe (from an underpayment penalty) if your total payments for 2023 are at least 110% of your 2022 tax or 90% of the final tax on your 2023 tax return.

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@Stevehofwa wrote:

 Some of the gains are offset by losses from the previous year, so the gain is less than initially reported to the irs.

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Your tax is based on the net gain for the year, after subtracting any capital loss carryover. You don't have to make a payment based on the gain from a sale if it will be offset by losses.

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@Stevehofwa wrote:

Can I just increase withholding for the rest of the year, or if I’m in the safe harbor region can I wait until April 15th.

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Yes, you can increase your withholding to cover the tax on the gain, instead of making an estimated tax payment. Unlike estimated tax, the timing of the withholding doesn't matter, as long as the total for the year is high enough.

You cannot wait until April 15 if you want to avoid an underpayment penalty.

[rjs]

@Stevehofwa  The first part of the answer that I originally posted was wrong. Please see the corrected answer above. Ignore the first part of the reply that you received in an email.

[Stevehofwa]

But if I pay all my taxes by 1/15/2024(last estimated date), via estimating or withholding, then am I clear?  I paid some by 6/15, but not all(should have just withheld maybe).  I

[Stevehofwa]

So estimated taxes do count?

[dmertz]

The corrected answer is still not quite right, although it's right if all of the tax payments are done via withholding, which seems to be the intent.  However, if tax withholding alone is insufficient to avoid an underpayment penalty, estimated tax payments must be made timely.  Making an estimated tax payment in early January 2024 would not be timely with respect to underpayment for quarters 1 through 3.

[Stevehofwa]

So it’s clear as mud.  How accurate does it have to be?  It seems to me that in general, if you are withholding, and have some unusual income, you just have to pay 110% of last years or 90% of this years during the year by withholding or by estimated in the year and you are good.  After all, how do I know I won’t have other losses to offset?   That’s why that rule is there, to avoid nitpicking.  Now if you are a business, I can imagine it’s different, you may be legally obligated since you don’t have withholding.

[Stevehofwa]

So I think I will just increase withholding for the rest of the year to get me to about what I expect to owe, so by the end of the year I’m in the safe harbor region.  And looked at the underlying IRS regs-it’s just mind numbing- what a mess.

[Mike9241]

unless you use the annualized income method, under the safe harbor 100/110% prior year tax or 90% this year's tax rules 1/4 must be paid in each quarter 4/18, 6/15, 9/15, and 1/16/2024. it can be through withholding or estimated tax payments or a combination of the two.

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for withholding the default is 1/4 is considered paid each period but you can use the actual amount (requires that form 2210 be filed). the one year I used actual, which was many years ago, I got a notice requesting proof. I used paystubs showing YTD withholding. I think this is unusual, but you never know. 

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from my experience knowing what the 90% will be is difficult if not impossible to determine before year-end (estimating higher than the actual 90% is ok), so the 110% is generally the safer option. I say generally because some taxpayers do not get all their tax info by the original filing date so must estimate what their taxes will be. too low and the payments in the early quarters may be short subjecting the taxpayer to penalties. Meeting either safe harbor makes you safe from penalties.

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[Opus 17]

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@Stevehofwa wrote:

So it’s clear as mud.  How accurate does it have to be?  It seems to me that in general, if you are withholding, and have some unusual income, you just have to pay 110% of last years or 90% of this years during the year by withholding or by estimated in the year and you are good.  After all, how do I know I won’t have other losses to offset?   That’s why that rule is there, to avoid nitpicking.  Now if you are a business, I can imagine it’s different, you may be legally obligated since you don’t have withholding.

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Even though 110% is a safe harbor, the payments must still be spread out evenly over the year, either by quarterly payments or withholding or a combination.  If you only made one estimated payment by the 4th quarter deadline (January 15), you could be subject to an underpayment penalty even if that payment brought you up to 110%. 

[NCperson]

@Stevehofwa - it is a headache, but you could prepare pro-forma forms 2210 to determine if your estimated payments are large enough to avoid any interest penalties. 

https://www.irs.gov/pub/irs-pdf/f2210.pdf