The United States income tax is a pay-as-you-go tax, which means that tax must be paid as you earn or receive your income during the year. There are two ways to pay as you go. One is through tax withholding and the other is through estimated tax payments. Topic 355 provides information on paying estimated tax. If you do not pay enough tax through withholding or estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Most taxpayers will have paid enough tax to avoid this penalty if, by January 15th of the following year, they have paid at least 90% of the tax owed for the current year, or 100% of the total tax liability for the prior year, whichever is smaller. However, if your adjusted gross income was greater than $150,000 last year, or $75,000 if you were married filing separate returns, the test is 90% of the current year tax or 105% of the prior year tax, whichever is smaller. In addition, if you made estimated tax payments, the payments must usually have been in approximately equal amounts to avoid a penalty. However, if you made unequal payments because your income was received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income. Use Form 2210, Underpayment of Estimated Tax by Individuals and Fiduciaries, to see if annualizing would reduce or eliminate the penalty.

There are special rules for farmers, fishermen, and certain higher income taxpayers. You will not have to pay a penalty for underpayment of 1998 estimated tax if your tax liability minus your withholding is less than $1,000. The penalty also will not apply if you had no tax liability for 1997, you were a U.S. citizen or resident for all of 1997, and your tax year included all 12 months of the year.

Also, the penalty may be waived if:

1. The failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty; or
2. You retired (after reaching age 62) or became disabled during the tax year a payment was due or during the preceding tax year, you had reasonable cause for not making the payment, and the underpayment was not due to willful neglect.
3. For estimated tax payments due on or before August 21, 1998, the penalty is waived to the extent your underpayment was created or increased by the IRS Restructuring and Reform Act of 1998.

For more information, see Publication 505, Tax Withholding and Estimated Tax. Publications can be downloaded from this site, or ordered by calling 1-800-829-3676.

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