IRS Underpayment Penalty of Estimated Taxes & Form 2210 Details
The IRS may charge underpayment penalties when you don’t pay enough in taxes throughout the year. Underpayment penalties can be a problem for self-employed taxpayers, independent contractors, or any taxpayer who has income that isn’t subject to tax withholding.
The best way to avoid underpayment penalties is to understand the safe harbors and pay enough in estimated taxes.
What Are IRS Estimated Taxes and When Are They Due?
Estimated taxes are quarterly payments you send to the U.S. Treasury. This money is allocated to the self-employment taxes and income taxes you incur during the year.
The IRS requires business owners to pay estimated taxes under the pay-as-you-go tax system. The four payment due dates are generally as follows:
- April 15
- June 15
- September 15
- January 15 of the following year
If these dates fall on a weekend or legal holiday, then the payment is due the next business day.
If you own a sole proprietorship or have an interest in a partnership or S-corporation, you may need to pay estimated taxes. Independent contractors, freelancers, and anyone who is paid as a “1099 worker” may also need to make quarterly estimated tax payments.
If you miss an estimated tax payment, pay it as soon as possible. Make your next payment on time to minimize penalties and interest.
What Is the IRS Underpayment Penalty?
The IRS charges the underpayment penalty when you don’t pay enough in estimated taxes. There are several situations where the IRS will assess this penalty:
- You don’t pay enough in estimated taxes over the course of the year.
- One or more of your estimated tax payments were late.
- You have an uneven income distribution during the year and one or more of your quarterly payments weren’t large enough to account for that quarter’s income.
The calculation for your underpayment penalty is a complicated formula. A larger underpayment amount will lead to a bigger penalty, and late payments may also increase your penalty amount.
What Is IRS Form 2210?
If you owe underpayment penalties, you may need to file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts. You can use this form to calculate your penalty or determine if the IRS won’t charge a penalty.
Even if you underpaid your taxes during the year, the IRS might not charge a penalty if you meet one of the safe harbor tests. Taxpayers who owe underpayment penalties are not always required to file Form 2210 because. In some cases, the IRS will calculate your penalty for you and send you a bill.
If you file or your tax preparer files your tax return using tax software, the software may prompt you to answer questions from Form 2210. The software may determine whether you need to file this form and how much you owe in underpayment penalties.
When to File Form 2210
Complete the flow chart on the top of Form 2210 to see if the IRS requires you to use this form. You don’t need to complete Form 2210 if any of the following apply:
- You owe less than $1,000 in tax for the year after subtracting your withholdings and refundable tax credits.
- Your withholdings and refundable credits are greater than 100% or last year’s tax liability or 90% of this year’s tax liability, whichever is smaller. However, you may need to file page 1 of Form 2210 if Box E of Part II applies.
- You may owe a penalty, but none of the boxes in Part II apply. In this case, the IRS doesn’t require you to file Form 2210. You still may use form 2210 to calculate your underpayment penalty.
The IRS will require you to complete Form 2210 if any of the following situations apply:
- You owe underpayment penalties and are requesting a penalty waiver. You only need to check the appropriate box in Part II and file page 1 of the form if you are requesting a waiver of the entire penalty. If you are only requesting a waiver for part of the penalty, you’ll need to figure your penalty amount.
- Using the annualized installment income method reduces your penalty amount. This may apply if you earned more income in some quarters than others.
- Your penalty amount is reduced if your withholdings are considered paid on the date withheld, rather than in equal amounts on the payment due dates.
- You filed a joint return in one, but not both, of the past two years, and the amount in line 8 is smaller than the amount in line 5.
For many taxpayers, the IRS doesn’t require them to file form 2210, they will calculate the penalties for you. Consult a tax professional if you aren’t sure whether you need to complete this form.
Instructions for Completing IRS Form 2210
Some taxpayers who need to use Form 2210, the IRS only requires them to complete and submit page 1. If you meet the requirements to figure your penalty amount, there are three methods you can use:
- Short Method
- Regular Method
- Annualized Income Installment Method
You can only use the short method if you made no estimated tax payments or paid the same amount on each of the four payment due dates. This method can calculate your penalty based on your underpayment for the entire year.
You must use the regular method if you made any late estimated tax payments, if you checked boxes C or D in Part II of the form, or if you are filing a 1040NR or 1040NR-EZ and didn’t receive wages as an employee subject to U.S. tax withholding.
If you had an uneven income distribution and checked box C in Part II of Form 2210, you’ll also need to use the penalty worksheet found in the instructions for Form 2210.
Both the regular installment method and the annualized income installment method involve complicated formulas. If you don’t qualify to use the short method, you may want to get assistance from a tax professional.
How to Avoid Underpayment Penalties
You can generally avoid underpayment penalties if you meet any of the following safe harbors:
- Taxes owed are less than $1,000 in tax for the year, after subtracting your withholding and refundable credits.
- You pay at least 90% of your current year tax in estimated tax payments.
- 100% of last year’s tax in estimated tax payments were paid during the year.
- You were a U.S. citizen or resident alien for all of last year. You also owed no tax for the year or weren’t required to file a tax return.
Special rules apply to farmers, fishermen, household employers, and taxpayers with AGIs above $150,000 ($75,000 if Married Filing Separately). If you have uneven income through the year, you may need to pay more in estimated taxes during some quarters.
If you aren’t certain what your income will be during the year, use the safe harbor based on last year’s tax liability. Simply take your total tax liability from last year, divide by 4, and pay at least this much each quarter.
If you also have W-2 income, you may be able to avoid paying any estimated tax payments. If you increase your W-2 withholdings enough so that you meet any of the safe harbor rules.
Keep in mind that even if you avoid underpayment penalties, you could still owe taxes when you file. For example, if your prior-year tax was $20,000, the IRS won’t charge underpayment penalties if you make timely payments of $5,000 each this year. However, if your income increased substantially and you owe $30,000 in taxes for the year, you’ll still face a $10,000 tax bill when you file your return.
Exceptions for Farmers and Fishermen
Farmers and fishermen can avoid the normal estimated tax payment rules if they receive at least two-thirds of their income from farming and fishing, and they are calendar-year taxpayers. They are only required to make one estimated tax payment by January 15 following the end of the tax year.
To avoid underpayment penalties, the payment must equal at least 66 ⅔% of their tax liability for the year or 100% of last year’s tax liability. The IRS doesn’t require farmers and fishermen who file their tax returns and pay all tax due by March 1 to make any estimated tax payments.