[USER]

Can someone please explain underpayment tax penalty to me? For the last 2 years, we have owed taxes…but does that mean we were automatically charged the penalty?

Where are we supposed to see the penalty amount? Or is it rolled in to the total amount owed?

1 year, we owed due to receiving SSDI backpay (my spouse’s income is high enough that we needed to pay for SSDI income).

We withheld taxes, but not enough.

We owed last year due to gains in our investment account…but how are we supposed to predict how the market will perform and adjust our taxes accordingly?

I know this question is coming… so I’ll briefly explain… most of our retirement accounts is “set it and forget it,” and we aim for long term capital gains.

Before we got financially savvy, my brother, who is a financial advisor, helped us with our joint brokerage account, IRAs, etc..

He does a lot of buying and selling of stocks, and as a result, it creates a lot of taxable events. He still manages those accounts.

Yes. I know it’s bad to to mix family and business. No, this situation is not ideal. It’s complicated and culturally nuanced. No, he doesn’t charge us a fee.

Since last year, we have been primarily funding a separate brokerage through a separate platform managed on our own.

If you really feel the need to comment on the relationship dynamic… go for it…but my question is solely about the tax penalty, and would appreciate some answers about that, too!

[Ron]

High enough prepayments through withholding plus estimation to avoid penalty assessment (line 38 of tax year 2024 1040):

1. Your estimated/withheld tax total exceeds your full tax liabilty the prior tax year. Example, total tax last year (2023) $25k.

Withheld this year $30k, but your total 2024 tax is $35k. You pay $5k difference, but no penalty because $30k withheld is greater than the $25k total tax in 2023.

2. Your withheld tax (plus any estimated tax sent in by the estimation deadlines) is within 10% of the final tax.

Example: 2024 total tax $40k, withholding was $30k. You didn’t know what your 2024 total tax would be, but knew you had some major income for which taxes weren’t withheld.

You sent in $6,200 estimated payment sometime during the 2024 tax year. Total payments $36,200. Tax $40,000.

You pay the $3,800 difference, but line 38 has zero, no penalty, because your prepayments are over 90% of the final total 2024 tax, so you are within 10%.

3. 2024 total tax liability is under $1,000. No penalty even though you have had zero tax withheld the whole year and haven’t sent in any estimated payments.

I do this every year for the last 8 tax years. My full tax owed each year has been less than $1k.

I pay $500, $600, $700 when I file, no penalty.

Hope this helps. I’m not an expert, just someone who has dealt with this.

[Kris]

You have to pay in either 90% of the current year liability or 100% of prior year (or 110% if over a certain income) to be penalty proof.

[Ron]

Line 38 of the 2024 1040 form is “Estimated Tax Penalty”. Presumably you’ll see an amount there if you have a penalty. It’s not estimating what your penalty will be.

It’s the actual penalty for your “estimated tax” (plus any withheld tax) not being high enough in advance of the tax filing season (see subcomment for 3 criteria to avoid the penalty).

[Alicia]

You have good info here on how to avoid the penalty, but to answer your question of how you know how much tax you will owe on your investments, your monthly investment statements will list exactly which securities have been sold and what dividends/interest you received.

You use that information to figure out how much tax you will owe and ensure you withhold enough to pay the taxes.

[Author]

Posts