Here is a three-step process that will enable you to review your overall tax situation during the last few months of this year so you can minimize any potential threat of underpayment penalties that may arise.

Tax Tips #1: Avoiding underpayment penalties

You can be assessed for underpayment penalties if your total tax due is $1,000. or more when you file your tax return. However, there are ‘safe-harbors” that protect you against penalties even if the tax you owe is $1,000. or more:

  • If your withholdings and estimated payments are at least 90% of the current year’s tax liability, you will not be subject to any penalties, provided you pay the difference by April 15 of the subsequent year.
  • If your withholdings and estimated payments are at least equal to last year’s tax liability you will not be subject to any penalties, with one exception: If your adjusted gross income is in excess of $150,000., you must pay 112% of the prior year’s tax liability in order to qualify for the “safe harbor.” This “safe-harbor” can be very advantageous for people who are experiencing a dramatic increase in income from the prior year. Even if your tax liability is two to three times greater in the current year you will be protected from penalties. You must pay the remaining tax you owe by April 15 of the subsequent year. In essence, you are receiving a short-term interest free loan from the federal government.

Tax Tips #2: It pays to plan

Individuals and business owners are not always aware that as the year progresses, they are accumulating a significant tax liability. If you are incurring a tax liability not subject to withholding throughout the year, you must make quarterly estimated payments to avoid the penalties. For calendar year taxpayers, the quarterly payments are due on April 15, June 15, September 15, and January 15 of the subsequent year. Business owners who are incorporated face similar rules. For calendar year corporations, the payments are due on April 15, June 15, September 15, and December 15. For fiscal year corporations, the payments are due on the 15th day of the fourth month, sixth month, ninth month, and twelfth month.

Tax Tips #3: Use the withholding rules to your advantage

You can compensate for earlier underpayments during the current year by adjusting your withholdings for the last few months of the year. The IRS considers withheld payroll taxes as being paid equally throughout the year, in spite of when actually withheld. In the case where your additional withholdings occur during the last few months of the year, bringing your total withholdings within the “safe-harbor” provisions, you will be able to avoid the underpayment penalties.