Paula Field, CPA, CFE
Safe Harbor for Tax Extension Payments
Updated: Apr 3
Here are the Safe Harbor rules on how to pay in enough on your taxes so that when you extend, the IRS won’t impose an underpayment penalty. Who wants more penalties? No one! This blog focuses on individuals but the penalty can pertain to estates and trusts as well as corporations.
But first, what does “Safe Harbor” mean? A safe harbor is a legal provision in a statute or regulation, in this case, the Treasury Regulations, that protects from legal liability or another penalty, in this case, penalty when certain conditions are met.
So in English, regarding your tax payments, the IRS will not issue you an Underpayment Penalty if you meet certain requirements with the amount of tax you pay before you file your return.
Remember!!! Filing an extension only allows you additional time to file your taxes. It does not give you more time to pay your taxes.
HERE ARE THE IRS RULES FOR SAFE HARBOR TAX PAYMENTS
The IRS will not charge you an underpayment penalty if:
1. You owe less than $1,000 in tax after subtracting withholdings and prior payments and credits.
2. You pay at least 90% of the tax you owe.
3. You pay 100% of the tax you owed for the prior year if your Adjusted Gross Income is less than $150,000.
4. You pay 110% of the tax you owed for the prior year if your Adjusted Gross Income is more than $150,000.
The IRS will not issue an underpayment penalty if:
1. Your Adjusted Gross Income is less than $150,000 for Married Filing Joint (MFJ) filers or less than $75,000 for Single (S) filers:
a) You paid timely 90% of your tax and/or you don’t owe more than 10% or $1,000.
b) You paid timely at least 100% of last year’s tax.
2. Your Adjusted Gross Income is more than $150,000 for Married Filing Joint (MFJ) filers or more than $75,000 for Single (S) filers:
a. You paid at least 110% of your last year’s tax on time.
Adjusted Gross Income is on line 11 of your 2021 and 2022 1040 US Individual Income Tax Return.
Total Tax Amount is on line 24 of your 2021 and 2022 1040 US Individual Income Tax Return.
What does timely mean?
The IRS is referring to people that are required to make estimated tax payments. If you have income that is not subject to withholding as from business operations, then you are required to make estimated tax payments during the quarter when you begin earning income…meaning Net Income from a business flow-through entity, aka a Partnership or an S Corporation.
Estimated tax installment payments are due four times a year:
· April 15
· June 15
· September 15
· January 15
If your CPA wants you to make a payment by January 15th, it’s because they are trying to reduce your penalties!
Since Partnership and S Corporation income technically flow through to your tax return when you receive a K-1 if you make your payment by January 15, this should be considered timely and you should be good to avoid the underpayment penalty.
EXCEPTIONS TO THE UNDERPAYMENT PENALTY
There are two exceptions to the underpayment penalty:
1. You had no tax due last year, you were a US citizen or resident alien for the entire year, and your return was, or would have been if you weren’t required to file, for a full 12 months.
2. Your total tax due minus the amount paid through withholding is less than $1,000.
Waiver of Penalties
If you have an underpayment penalty, it can be waived if you meet one of the two criteria:
1. You retired after reaching 62 or became disabled during the last two years and your underpayment was due to a reasonable cause and not willful neglect.
2. The underpayment was due to a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.
Aside from disaster, the IRS has Treasury Regulations that must be met in order to get a waiver of penalties and they are not in favor of granting those right now.
If you pay in more than is due on your return…let’s say you are a high-income earner and you paid in 110% of last year’s tax and after your file, you have overpaid. You have two choices of what to do with those funds.
1. You can apply the refund to next year.
2. You can request the refund be returned to you either via electronic deposit or a check…I would take the electronic check and avoid it getting lost in the mail!
In summary, the easiest and best way to avoid an underpayment penalty is to:
1. Determine if your Adjusted Gross Income (AGI) was more than or less than $150,000 on line 11 of last year’s return.
2. Determine how much has already been paid in via withholdings or estimated tax payments.
3. Make your estimated tax payments by their due date.
a. If AGI is less than $150,000 (MFJ) or $75,000 (S) to bring the amount paid in up to 100% of last year’s total tax, line 24.
b. If AGI is more than $150,000 (MFJ) or $75,000 (S) to bring the amount paid in up to 110% of last year’s total tax, line 24.
What if it’s after January 15th and you haven’t made a payment?
My best advice is to run the calculation and make a payment as soon as possible. This will stop the penalty from accruing.
The underpayment penalty is 5% of the underpaid amount for each month it is late and capped at 25%, and this penalty continues to accrue interest until it is paid in full.