When you do your taxes in tax software, the software sometimes calculates an underpayment penalty. It thinks you owe the penalty when your tax withholding plus any estimated tax payments were below a certain threshold (the “safe harbor“):
- Within $1,000 of your tax obligation; or
- 90% of your current year’s tax obligation; or
- 100% of your previous year’s tax obligation (110% if your AGI in the previous year was $150,000 or more)
If your income was uneven throughout the year, you can try to get out of paying the underpayment penalty through a complicated exercise using the “Annualized Income Installment Method.” It basically comes down to doing your taxes four times by separating your income and deductions into four sub-periods within the year and calculating your taxes for each sub-period.
I don’t know about you but I don’t have any appetite for doing my taxes four times.
There’s a much better way. The tax software is only trying to be helpful in calculating the underpayment penalty for you. You can decline its help and let the IRS calculate the penalty and bill you if they decide to assess a penalty.
The IRS actually often doesn’t assess a penalty when the tax software thinks you owe a penalty. You don’t have to volunteer the penalty now.
Here’s how to opt out of calculating the underpayment penalty in TurboTax and H&R Block software.
I’m using TurboTax downloaded software. TurboTax downloaded software is both more powerful and less expensive than TurboTax online software.
Find “Underpayment penalties” under Federal Taxes -> Other Tax Situations. Click on Start.
If TurboTax says you have a penalty for underpayment. Click on Continue.
TurboTax asks you about farming or fishing, which doesn’t apply to most people.
You can continue the confusing interview with more hoops to jump through but it’s much quicker if you switch to the Forms mode now by clicking on Forms on the top right.
TurboTax opens a form. Check the box next to item C to have the IRS calculate the penalty and send a bill if necessary. Chances are they won’t.
The underpayment penalty calculated by TurboTax is removed immediately after you check that box. Note in our example the tax owed meter dropped from $1,308 to $1,262 after we checked the box.
Click on Step-by-Step to return to the interview.
You’re back to the screen about farming and fishing. Click on “Other Tax Situations” in the sub-menu to exit this section.
It’s much more straightforward in the H&R Block downloaded software. H&R Block download is also both more powerful and less expensive than H&R Block online software.
Find “Underpayment Penalty” under Federal -> Taxes. Click on Go To.
H&R Block offers the option to let the IRS calculate the penalty right away. The option is selected by default.
H&R Block explains that it won’t cost you any more to have the IRS calculate the penalty. It actually will cost you less when the IRS doesn’t assess a penalty.
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.