The United States operates on a pay-as-you-go tax system, meaning individuals must pay income tax as they earn or receive income throughout the year. This can be done through tax withholding or by making estimated tax payments. If an individual does not pay enough tax through these methods, they may be subject to a penalty for underpayment of estimated tax. Generally, a taxpayer can avoid this penalty if they owe less than $1,000 in tax after accounting for withholding and refundable credits, or if their total withholding and estimated tax payments equal at least 90% of the current year's tax liability or 100% of the prior year's tax liability, whichever is smaller. Special rules apply to farmers, fishermen, certain household employers, and higher-income taxpayers. More details can be found in Form 1040-ES, Estimated Tax for Individuals.
To prevent penalties, estimated tax payments should generally be made in four equal installments. However, for those who receive income unevenly throughout the year, the annualized installment method may be used to adjust payments and potentially lower penalties. Taxpayers can use Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to determine if they owe a penalty.
In certain cases, the IRS may waive the penalty, such as when:
A payment was missed due to a casualty event, disaster, or other unusual circumstances, and applying the penalty would be unfair.
The taxpayer retired after reaching age 62 or became disabled during the tax year or the previous year, and the underpayment was due to reasonable cause rather than willful neglect.
For further information, refer to the IRS guidelines on penalties and the Instructions for Form 2210. Additional details can be accessed at IRS.gov.