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Can I avoid underpayment penalty?

This is the first time in 35 years that I am making estimated tax payments instead of simply relying on withholding. Based on my (perhaps faulty) assessment of the situation, it appears that I cannot avoid underpayment penalties when I file next year. Am I overlooking or misunderstanding something?

During the first payment period, my taxable income, ergo my est tax, was very low. In the second period, I had a windfall due to exercising employee stock options (wage income subject to withholding) and liquidating a large amount of stock (capital gain; no withholding). The second-period taxable income is 10 times the first period's. But the withheld taxes are sufficient to cover my total expected year-end tax liability, let alone the minimum payment for the period. The problem seems to be with the very low first-period payment. When I look at Form 2210, I do not meet the safe-harbor conditions in Part I. I do not qualify for the Short Method in Part II. If I use the Regular Method (Part IV), the first required installment is about 25% of the total tax liability -- far more than I actually paid due to the very low first-period taxable income. If I use the Annualized Income Method (Sched AI), my actual second-period payment is substantially less than the computed required payment because the method would have me multiply the one-time by 2.4, as if I expect the windfall to continue for the remainder of the year. (Not!) So both methods seem to result in a substantial underpayment penalty. And yet I believe I paid prepaid the taxes in a timely manner, having paid the full amount of taxes (and more!) due to the windfall as well as covering my normal expected taxable income. Am I misunderstanding Form 2210?

Do I have any other recourse to avoid the "underpayment" penalty? According to Form 2210 instructions, there is a procedure for requesting a waiver of penalty. But based on my (perhaps faulty) interpretation, I do now qualify. Although I retired in 2005, I am not yet age 62; nor am I disabled. The penalty could be waived due to "unusual circumstances". But the examples are casualty and disaster. I do not know if "windfall" would qualify ;-). Do I misunderstand the waiver and its (in)applicability to me? If any tax professionals in this forum have experience with similar situations (I would think it is not so uncommon), I would appreciate any guidance in understanding how I might (legally) avoid the underpayment penalty, given that I believe I have indeed followed the "pay as you go" principle. (That is, I am not attempting any kind of tax-avoidance scheme whatsoever.)

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Reply to
nomail1983
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If your withholding (including the withholding on the options) covers your entire tax liability for the year, you will have no underpayment penalty. Withholding is treated as if it had been paid evenly over the year, regardless of when it was actually paid. Katie in San Diego

Reply to
Katie

Then there's no problem. If total tax minus withholding is less than $1,000 there's no estimated tax penalty, even if all the withholding happened on December 31. See IRS Publication 505.

-- Phil Marti Clarksburg, MD

Reply to
Phil Marti

The "one-time __windfall__".

"I do __not__ qualify".

Reply to
nomail1983

Your first payment will be O,K. and you should size #2 payment (June 15) with the AI method, which will probably have you pay 1/2 of last year's tax, minus whatever you paid in the first installment. You are correctly calculating the annualized installment for the second quarter, HOWEVER, the AI method will not use that figure when it is more than 1/2 your last year's tax. If you already paid in withholding and estimates more than last year's tax, or more than 90% of what this year's tax will be, you don't owe any more until next April. The withholding on your stock options will average over all 4 quarters, so you probably didn't underpay the first quarter, even on the Regualr or Short Method. You probably didn't have to make the ifrst installment at all. Get a 2210 tax calculator downloaded from the net and it will do all the calculations for you and computet the correct amount of installment to pay each quarter. ed

Reply to
ed

I think the OP should clarify that he is talking about payroll withholding, and not Quarterly Estimated Tax Payments. If not withholding, the answer may change.

Reply to
Gil Faver

Yes. I'm afraid I made two c> But the withheld taxes are sufficient to cover my total

That was an exaggerati> When I look at Form 2210, I do not meet the

That was the correct statement. Working through Part I, I would check "Yes, you may owe a penalty" in line 9. Thanks for the responses so far. I apologize for misleading you.

Reply to
joeu2004

Well, both!

I think I made that clear when I wrote: "This is the first time in 35 years that I am making estimated tax payments instead of simply relying on withholding". So yes, I am making periodic est tax payments per Form 1040-ES. But I also noted that I "exercis[ed] employee stock options (wage income subject to withholding)". So yes, I also have some payroll withholding.

Reply to
joeu2004

Ding! Well, 1/2 of 100% or 110% of last year's tax, whichever is applicable. My mistake. Thanks for pointing this out.

Reply to
joeu2004

If you haven't made the estimated tax payment yet, can you increase your withholding for the rest of the year by enough to cover it? (E.g. increase your monthly withholding by 1/6 of the estimated tax payment)? Then you have money longer (use the money you would have paid in estimated taxes now to replace the money withheld), and you're safer from the penalty for underpayment.

Seth

Reply to
Seth Breidbart

This is really very simple. Add up your withholding, salary and options, so far this year, plus what you expect for the rest of the year. Add to that any estimates payments you have made. Does that total more than your total taxes last year? (110% of last year's tax if your AGI lasy year was over $150K). If so, you don't have to pay any more. If not, there's several things you can do to avoid a penalty including applying withholding in the quarter it was incurred instead of averaging, or increasing your withholding to make up any deficiency, or continuing with installments. If you can't figure it out, we'll help, but we have to know some figures. ed

Reply to
ed

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