Estimated tax safe harbor
90% estimated tax rule / 110% safe harbor / underpayment penalty safe harbor
The estimated tax safe harbor is the IRS rule that protects a taxpayer from the underpayment penalty. Paying at least 90% of this year's tax or 100% of last year's, whichever is smaller, generally avoids it, with 110% of last year's tax once adjusted gross income passed $150,000.
The US income tax system is pay-as-you-go. Tax is due as income is earned, through withholding or estimated tax payments, and paying too little during the year can bring a penalty. Profit from a business usually has nothing withheld, so estimated payments do that job.
The IRS topic page gives the general rule. Most taxpayers avoid the penalty if they owe less than $1,000 after withholding and refundable credits. They also avoid it if withholding and estimated tax reached at least 90% of this year's tax or 100% of last year's, whichever is smaller.
Publication 505 adds the adjustment for higher incomes. If adjusted gross income on the prior year's return was more than $150,000, or $75,000 for married filing separately, the prior-year figure becomes 110%. Income from farming or fishing follows special rules.
The prior-year test holds up in a strong year, because its target is fixed once last year's return is done. The current-year test depends on a figure nobody knows until the year ends. The IRS generally expects payments in four equal amounts, and a business with uneven income can use the annualized installment method instead.
In practice
An owner's tax on last year's return was $40,000, on adjusted gross income of $210,000. This year the business grows and the tax comes to $70,000. Paying 110% of last year's tax, $44,000, in four payments of $11,000 meets the safe harbor, though 90% of this year's tax would have been $63,000. The rest is due with the return. The figures are a worked example.
Why it matters to you
Estimated payments sized to a forecast of this year's profit fall short when the year goes well. Sizing them to 100% or 110% of last year's tax sets a target known in advance that still avoids the penalty. The IRS can also waive the penalty in limited cases, such as a casualty event or disaster.
What to ask or check
- 01Were this year's estimated payments set from last year's tax or from a forecast of this year's?
- 02Was last year's adjusted gross income above $150,000, so the 110% figure applies?
- 03If income arrived unevenly, would the annualized installment method lower or remove the penalty?
What people get wrong
That avoiding the penalty means paying 90% of this year's tax. The rule takes the smaller of that or 100% of last year's tax, and 110% once adjusted gross income passed $150,000.