The United States income tax is a pay-as-you-go tax, which means that tax must be paid as you earn or receive your income during the year. You can either do this through withholding or by making estimated tax payments. If you do not pay your tax through withholding or do not pay enough tax that way, you might also have to pay estimated taxes. If you did not pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. How much you owe or have refunded is the difference between your tax less credits you qualify for and what you have pre-paid through estimates and withholding. A lot many taxpayers end up paying more than their tax because they got caught by the Penalty for Underpayment of Estimated Tax.
Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. There are special rules for farmers and fishermen, people who have household employees and higher income tax payers.
Generally, the payments should be made in four equal amounts to avoid a penalty. However, if your income is received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income and making unequal payments. The penalty may be waived if:
The failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty, or
You retired (after reaching age 62) or became disabled during the tax year for which estimated payments were required to be made or in the preceding tax year, and the underpayment was due to reasonable cause and not willful neglect.
You can also get hit with the penalty if you are getting a refund. Let’s say you had large gambling winning in February but you held off making an estimated payment until the next quarter. Depending on the amount of the winnings and the size of the payment, you could still have to pay the underpayment penalty even if you’re getting a refund.
To avoid paying penalty for Underpayment of estimated tax, you want to make estimates or make sure your withholdings are enough to prevent the penalty. Your tax is your tax but there’s no need to pay more when it’s not hard to pre-pay enough to cover it.