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[Video] Taxes: Underpayment Penalties Aren’t Worth Paying

by Financial Design Studio, Inc. / May 11, 2020

[Video] Taxes: Underpayment Penalties Aren’t Worth Paying

 

No one enjoys paying money to the state or the IRS. When they’ve already withheld and then they find they owe a balance still.

On top of that, adding insult to injury, there is also underpayment penalties and interest.

Let’s talk through some examples so that you know now whether it is the end of the year and you can make a tax payment or you are at the beginning of the year and you can adjust your withholdings and adjust for what you want.

How can you avoid all of that? It’s called safe harbor.

We’re going to look at a couple examples of how we get to those numbers. It sounds really involved but it is actually really easy. 

So looking at last year’s return, if you made $100,000, using really round numbers for understanding. 

They had $10,000 in taxes and out of their paycheck they had $9,000 taken out. So at the end of the year they were $1,000 short. 

Normally you’d think if you have a balance due, you think you have until April. Which in some cases, yes you do.

But there are some cases we’ll want to look at.

  1. Is the amount outstanding over $1,000? In this case, it is not. They met rule number one. No underpayment, no interest because cause the amount due is not greater than $1,000. 
  2. This amount here that they had withheld, was 90% of what their tax balance was. 

So now we fast forward to this year. We are going to show that they got a raise, a bump up in salary, or a bonus as year end. Now that their income went up it is hard to know what the balance due is going to be and what the taxes are going to be. The 90% of these is a moving target. 

What they could do is called safe harboring. It is looking at what last year’s tax was and take 100% of that which is $10,000, they will be in safe harbor. Meaning there may still be a balance due, and they would have until they file their tax bill to pay it, but there won’t be any additional underpayment penalties or interest. 

3. So that is rule number three – to pay last year’s full taxes to be covered by safe harbor. 

4. Next we look at their income and it goes over a threshold and let’s just say they are above $150,000. Rather than being at over 100%, it is 110%. 

So rather than looking at the past two years and paying 100%, They would have to pay in $11,000, 110% of last year’s tax in order to avoid underpayment and interest.

So I just talked about a lot of things. Let’s go through the rules really quick. 

  1. If your tax due is under $1,000, any year, there are no underpayment penalties. 
  2. If you pay 90% of the current tax in payments, you avoid the underpayment penalties. 
  3. If you pay 100-110% based on your income, that is another way of avoiding underpayment penalties and interest. 

So, you never like to pay taxes. Throwing in additional interest and penalties isn’t fun. So how do you keep more. Because ultimately it’s not about how much you make it is about how much you keep. And our goal is to help you keep as much as possible. 

Wondering how this affects your finances? Contact us to discuss!

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Financial Design Studio, Inc.

Financial Design Studio, Inc.

We are financial advisors in Deer Park and Barrington, IL. A team with a passion for helping others design a path to financial success — whatever success means for you. Each of our unique insights fit together to create broad expertise, complete roadmaps, and creative solutions. We have seen the power of having a financial plan, and adjusting that plan to life. The result? Freedom from worrying about the future so you can enjoy today.