Don’t Get Caught With an Underpayment Penalty!

Avoid penalties on underpayment of estimated taxes by increasing withholding for year end.

United States tax law requires that taxpayers over the course of the year make tax payments equal to the lesser of 90% of the tax owed for the current year or 100% of the tax due in the prior year. Special rules apply to high income taxpayers with adjusted gross income in excess of $150,000 for those using the married filing joint status and $75,000 for those filing with any other status. These high income taxpayers are required to pay 90% of the current year’s taxes or 110% of the prior year’s taxes in order to avoid underpayment penalties.

Payments are made throughout the tax year either through withholding from wages, pensions, and other income or through quarterly estimated tax payments.

The underpayment penalty is equal to the current federal interest rate and is assessed on a quarterly basis. With bank and other investment interest rates at current all-time lows it’s a wise move to avoid paying the government a penalty for underpayment of estimated taxes.

In order to avoid these penalties taxpayers should evaluate their tax position for the current year and determine if the amounts withheld from payroll, pensions, and other income will be sufficient to cover their projected tax liability. If these amounts fall short there is still time to do something about the shortage.

Since penalties are based on the timing of payments increasing estimated tax payments at this time while reducing the penalty will not eliminated for prior periods. There is however still a way to in effect turn back the clock and make the payments that were due earlier during the year. To do this you must simply make the payments through withholding from payroll, pensions, or other income. Now is the time to contact the payroll agent for your company or the withholding agent for your pension and ask that they increase the amount being withheld for 2012 taxes. Withholding payments are counted by the government as being made equally over the tax year regardless of when the withholding takes place. This in effect allows you to make up for missed or shorted payments which were made earlier during the year.

In order to take advantage of this simple strategy you must act now before year-end.