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I have never owed federal taxes and had an underpayment for any given year but there is a possibility of that occurring on current 2021 tax year.

Right now I could get into a situation where my 2021 underpayment will be $10k. I am wondering if I would have to pay the irs some sort of penalty for under payment? Long term cap gains and options income got a little out of hand.

Here is what I found through Google search

https://www.hrblock.com/tax-center/irs/refunds-and-payments/...

"If you pay 90% or more of your total tax from the current year’s return or 100% of your tax from the prior year, or you owe less than $1,000 in tax after withholdings and credits"


I read this as I am ok and don't have to pay interest or fee for the possible $10k underpayment.
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Just to make sure I painted correct picture I currently am w2 employee and pay taxes every year and had enough withheld every year to get a refund and 2021 might be the only tax year I run into trouble of tax underpayment due to not withholding enough on biweekly checks.
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ProjectChris,

"If you pay 90% or more of your total tax from the current year’s return or 100% of your tax from the prior year, or you owe less than $1,000 in tax after withholdings and credits"

They are talking about how much you are having withheld this year 2021. If the total of all taxes withheld from any sources in 2021 covers 90% of what your Total TAX for 2021 when you fill out your return, then there will not be a penalty. Alternatively if the total withheld in year 2021 is equal to or greater than your Total TAX reported on your 2020 tax return, then there will be no penalty. Or if your total due is less than $1000 due for 2021, then no penalty.
If you meet any one of the 3 requirements you are ok.

So if you calculate how much is being withheld with each paycheck and you can estimate where you will end in 2021 then you can look at your 2020 return. If you withheld more than your 2020 Total TAX on that return then you are good.

For many years I kept a running total at the end of each month, so there would be no surprises.
I now am retired and keep a total of all IRA Taxable Distributions each quarter and I can then adjust my estimated taxes each quarter to avoid any penalties and not overpay either.
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Here is what I found through Google search

https://www.hrblock.com/tax-center/irs/refunds-and-payments/......

"If you pay 90% or more of your total tax from the current year’s return or 100% of your tax from the prior year, or you owe less than $1,000 in tax after withholdings and credits"

I read this as I am ok and don't have to pay interest or fee for the possible $10k underpayment.


Maybe. There's a second part that you didn't copy into your post:

If your adjusted gross income was $150,000 or more (or $75,000 if you’re married filing separately) then you may not be subject to the penalty if you paid the lower of 90% of the tax shown on the current year return, or 110% of your tax from the prior year.

Will your AGI, including this additional income, be over $150k? I ask because if all of the additional income is taxed at a LTCG rate of 15%, that would mean $10k in additional taxes would indicate $67k in additional income, which could push you over $150k in total income if your W-2 job pays at least $83k. If so, then you need to use the 2nd rule, not the first one.

In either case, you need to be sure that your Federal withholdings from your W-2 job add up to more than either last year's tax liability (110% of last year's liability if your AGI will be over $150k), or that your Federal withholdings from your W-2 job will be at least 90% of your total liability this year.

I'm going to guess that with a potential $10k in additional taxes due, you won't meet the 90% of this year's liability rule, because that would mean that with $10k in additional taxes due, your withholdings from your W-2 job would be at least $91k So as an example of the requirement to withhold at least as much in taxes as the prior year:

Let's say you had $12,000 in Federal income taxes withheld from your W-2 job last year, and you got a Federal refund of $2,000 That means that your Federal tax liability last year was $10,000 If your AGI is under $150k this year (including the additional income), and your Federal withholdings will be at least $10k this year, then you're good. If the additional income will push your AGI will be over $150k this year, and your Federal withholdings will be at least $11,000 this year, then you're good.

If your Federal withholdings this year won't be enough to push you over last year's tax liability (110% of last year's liability if your AGI will be over $150k), then you could change the W-4 at your W-2 job to have additional taxes withheld for the rest of the year.

If your state has an income tax, you should check your state's rules on underpayment, too.

AJ
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...not withholding enough on biweekly checks.

...then you could change the W-4 at your W-2 job to have additional taxes withheld for the rest of the year.


Isn't another alternative to just get on irs.gov and make a payment from your bank account, either for the entire $10k or at least enough to avoid problems?

I'm asking partly because I did just that earlier this year without filing any forms for estimated taxes, I just made sure they had the money to cover a ROTH conversion where 100% of the withdrawal from the IRA went into the ROTH; I was paying the corresponding taxes from other money. A one-time event covered by an immediate one-time payment. (Yes, I remembered to do the same for the state.)
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Isn't another alternative to just get on irs.gov and make a payment from your bank account, either for the entire $10k or at least enough to avoid problems?

Yes, that's another alternative. But if the income that's causing the additional taxes was received in earlier quarters than the payment is made, there could still be an underpayment penalty based on timing, if a safe harbor to avoid underpayment penalties isn't met.

I'm asking partly because I did just that earlier this year without filing any forms for estimated taxes, I just made sure they had the money to cover a ROTH conversion where 100% of the withdrawal from the IRA went into the ROTH; I was paying the corresponding taxes from other money. A one-time event covered by an immediate one-time payment. (Yes, I remembered to do the same for the state.)

Direct payments to the IRS are still considered to be a quarterly estimated payment (as opposed to withholding), even if you didn't file the forms. Since your payment was basically at the same time that the income was realized, you wouldn't run into any issues with timing.

AJ
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To Leosource, I saw your email but that email goes to a readonly dead box.

I have this set so I only reply from inside the fool discussions.

I do not use a spreadsheet to get exact numbers for Estimated taxes. Just ball park with a small Google Sheet doc. I don't have the need for that much detail. If I deduct 20K from an IRA I add the tax that I have a rough idea of from history and add that to ES Taxes for the same quarter. I start the year with ES taxes for all 4Qs to cover SSA and Pensions which do not change much. I then do an extra ES payment if I do more than 5K withdraw from IRA in any quarter. Gets me close enough without doing overpayments. I usually wind up owing a few hundred to the IRS when I file.

Would rather have the money invested instead of having the IRS holding a big bag of money and giving me a big refund. I do watch my tax brackets and avoid going into a higher bracket. If you watch it you get a feel for where you are at each quarter.

With Big Swings in Capital gains / losses Q to Q you would need more detail than I do to keep yourself out of penalties.

I Learned from a return I filed late one year. Was sick and let it slide. Plus I didn't watch my EStaxes. Had a lot of OT earlier that year and Capital Gains. Got hammered with late fees, interest and penalties. Learned my lesson and started watching things quarterly from then on.

Best of luck in finding what you need, but be careful.

Mike2020R
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I am filing head of household.

Here is my issue. I plan taxes to almost be break even every year and I took the plunge to sell options in June of this year. I max out 403b and 457b every year and currently have $41k worth of fed/state taxable w2 income and will finish with around $47k. Add in around $25k long term cap gains and $25k worth of short term gains so around $97k before $23k worth of itemized deductions. I want to avoid taking more out of my check because I want to fully fund the 457b which is another $8k or so left to fully fund for 2021 and I only have $1635 federal withholding for the year so far.

I really got in over my skiis with a spread that went bad on expiration date and had to sell a stock with a lot of long term cap gains so I got all out of whack on my plan between a bunch of short term cap gains and long term cap gains getting higher than I had planned as I did bail myself out of trouble on the put sale spread gone bad at expiration and will likely not book a large loss on that anymore.(i typically harvest long term cap gains since they are taxed at 0% with fed taxable income under approx. $54k)
My original plan was that my long term cap gains would fall into the 0% favorable long term cap rate.


Long winded way of saying I didnt expect all these gains and now I am in a situation to try and avoid a penalty for underpayment.--- not complaining just dealing with what I got in front of me.

I probably need to recheck my capital gains to make sure I got the math right though. I am assuming I close out the huge spread trade in December. Tempted to roll the entire spread into next year so I can book a large loss in 2021. (I sold 100 contracts $300/$295 upst put bull spread and rolled into December $290/$280

I also plan to retire from my job at end of january.
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I am filing head of household.

The $150k AGI that moves you into the 110% safe harbor rule doesn't consider filing status.

Add in around $25k long term cap gains and $25k worth of short term gains so around $97k before $23k worth of itemized deductions.

Deductions are only counted after calculating AGI. That said, if the $97k is going to be your total taxable income for the year, then you are fine to use the safe harbor rule of ensuring you have paid 100% of 2020's tax liability, rather than the 110% rule. If closing out other positions will add enough so that you will end up with more than $150k in taxable income before deductions, then you will need to have paid the IRS 110% of 2020's tax liability.

I want to avoid taking more out of my check because I want to fully fund the 457b which is another $8k or so left to fully fund for 2021 and I only have $1635 federal withholding for the year so far.

You are free to use another method to pay the IRS https://www.irs.gov/payments Just be sure you pay enough to meet the safe harbor.

I also plan to retire from my job at end of january.

Since you won't have a paycheck that will withhold any longer, you might want to read up on making estimated tax payments https://www.irs.gov/payments/pay-as-you-go-so-you-wont-owe-a... I would also point out that if you are going to be taking money from pre-tax IRAs or employer plans, you can have withholdings from those accounts, and you can do it all at once in December instead of having to make estimated tax payments throughout the year.

AJ
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Thanks for all your help 🙏


Now, I went through all the math.


Estimated w2 income= $54k
Estimated crypto interest income= $3k
Current long term cap gain= $29k

Current short term cap gains if my spread expires worthless= $20k
Current short term cap gains if I roll the spread into next year= -$5k

Current Federal withholding= $1690

Estimated itemized deductions= $23k

Child credit= $3k-$1500= $1500

Tax owed if spread expires worthless= approx. $7300
Tax owed if I roll the spread at current market prices= approx. $600


I looked into how much interest penalty is and from what I gathered is 0.5% per month of the tax I owe so the penalty would amount to less than $500 on $7300. I am gonna roll the dice and hope the safe harbor shelters me from this penalty.

I really want to be finished with the spread gone bad that I rolled out into December so I am hoping it expires worthless so I can pay irs $7300 and save the stress of potential max loss of $100k with 100 contracts on $290/$280 put bull spread expiring 12/17/2021. Right now that looks like good odds to expire worthless with current price of $385. I got a little crazy with my first bull put spread i wrote but I pushed the edge enough to learn the risk that is for sure.


Chris
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Estimated crypto interest income= $3k

If you had any crypto transactions, you will also have capital gains/losses associated with them. These include exchanges, sales, using crypto to pay for goods/services, etc. This is an area of current interest within the IRS and they are getting more aggressive in tracking these transactions. Note the check box at the top of page 1 of Form 1040 and the jurat statement just above your signature on page 2.

Ira
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I glanced through the responses and am not sure I saw one fairly straightforward approach you can take to avoid a penalty for this year. Forgive me if it was already shared.

One of the federal safe harbor rules is if you pay at least 100% of the taxes you owed for 2020 (110% if you’re considered high income) through withholdings by the end of 2021.

Since you indicated that you are retiring in January 2022, I presume you still have a paycheck between now and then. Your employer should let you adjust your withholdings upwards for your remaining paychecks for 2021, which could let you meet that particular safe harbor target. It would lower your take home pay, but if you still have the money from the gains that generated this unexpected income, you could use that to supplement any cash flow shortfall driven by the lowered paycheck.

If you meet that safe harbor test, you can true-up the rest of what you owe Uncle Sam for 2021 by April 15, 2022 and not owe any interest or penalty.

Your state and/or local taxing jurisdictions may have similar safe harbor tests you can use.

Regards,
-Chuck
Home Fool
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Quick clarification:

One of the federal safe harbor rules is if you pay at least 100% of the taxes you owed for 2020 (110% if you’re considered high income) through withholdings by the end of 2021.

Should instead say:

“One of the federal safe harbor rules is if you pay enough through 2021 withholdings in 2021 to cover at least 100% of the taxes you owed for 2020 (110% if you’re considered high income).”

Regards,
-Chuck
Home Fool
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Remember to check state taxes if you are in a state with state income tax.
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“One of the federal safe harbor rules is if you pay enough through 2021 withholdings in 2021 to cover at least 100% of the taxes you owed for 2020 (110% if you’re considered high income).”

Thanks, appreciated 🙏

This clarification above helped tremendously. For some reason I interpreted as I paid 100% or more of 2020 taxes through withholdings from 2020


Same safe harbor rules apply for my home state of Indiana from what I read.
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Thanks,


Indiana has same safe harbor rules.

My employer makes it an easy process to withhold for federal taxes but is a big ordeal for withholding for state income taxes.

Unbelievable, you would think they could make paying the state through withholdings much easier.

I just can't believe how many processes I see on a daily basis that can be improved to make easier and simpler. Has me wondering if it is really the year 2020. I work in healthcare so maybe that is the problem..

I got my social contract in today and might just end up quiting to gain access to my assets and reapply as part time .5 fte status. I told my boss I want a clean break so I can access my 457b and 403b assets.

Plan on eventually 72t my 403b once I get those assets to $1 million.

I am going to utilize my 403b and 457b as a bridge to age 59.5.

I got 15 years to draw down those assets before age 59.5.
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One of the federal safe harbor rules is if you pay at least 100% of the taxes you owed for 2020 (110% if you’re considered high income) through withholdings by the end of 2021.

The CARES Act suspended RMD for 2020. I didn't withdraw any RMD from my IRA accounts resulting in a taxable income of $38,343.00 and income tax $2,375.00.

For 2021 my RMD was $141,541.00. I estimated that my tax liability for 2021 would be $34,752.00 for 2021. I scheduled quarterly payments of $8,688.00 through EFTPS. The last quarterly payment will be withdrawn from my bank account in December.

I have approximately $45,000.00 in unanticipated capital gains in 2021. As I've paid significantly more than 110% of my 2020 tax liability, have I satisfied the safe harbor rules?
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As I've paid significantly more than 110% of my 2020 tax liability, have I satisfied the safe harbor rules?

Yes.
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