Estimated Taxes Are a Pain. Here’s How to Avoid Costly Penalties.

Most of these payments are on income that doesn’t have taxes withheld, unlike employee pay. Recipients of non-withholding income include investors, retirees, business owners and gig workers.

Estimated-tax penalties have surged recently. Such penalties reported by filers earning between $200,000 and $500,000 were about $1.3 billion for 2024, or triple the 2021 amount, according to Internal Revenue Service data. Over the same period, the number of affected filers grew 30%, to about three million.

Tax advisers are seeing the surge. “These penalties are more on our radar because people are having life changes like retirement, gig work is expanding and investment accounts have grown,” says Jan Lewis, a CPA and tax specialist in Jackson, Miss., who is vice chair of the American Institute of CPAs. “Also, they’re very, very confusing.”

Here’s the background: U.S. tax law requires filers not only to pay their taxes, but to pay them on time. Since World War II, when lawmakers expanded the income tax and instituted paycheck withholding, employees have had taxes sent directly to the IRS from wages.

To prevent gaming, the system requires people with income not covered by withholding—such as from investments or self-employment—to pay estimated taxes on each quarter’s income. Filers who fall short often owe an interest-based penalty on the underpayment for the quarter.

So if an investor has a $10,000 capital gain in February and waits until December to pay taxes on it, he could owe an underpayment penalty for three quarters.

For all of 2025 and the first quarter of 2026, the rate on quarterly underpayments has been 7%. Although that’s dropping to 6% on April 1, it’s still far higher than the 2021 rate of 3%. This is one reason estimated-tax penalties have grown.

Taxpayer confusion is surely a factor as well. The estimated-tax rules are one of the tax code’s most treacherous minefields, especially for filers who have income that’s eligible for withholding and income that’s not.

Bob Carlson, a well-known adviser on retirement issues, concurs that tax filers are befuddled. “I think a lot of people are trapped by these penalties and embarrassed to talk about them,” he says.

Even filers who have avoided the penalties stress about them. Peggy Dufour is a retiree living outside Washington, D.C., who consults on contracts for the Energy Department.

“I can handle a $32 billion contract, but I don’t know enough about estimated taxes to be sure I’ve done the right thing,” she says. “I worry about it constantly because my income is unpredictable.”

Ironically, the law offers ways to avoid the penalties—if you understand the nuances. Here’s more.

Know the fundamentals

Filers who owe $1,000 or more of tax normally must pay 90% of their tax bill for the current year long before the April 15 due date to avoid penalties. They can pay through withholding, quarterly estimated taxes or both. The deadline is Dec. 31 for tax paid through withholding. The 2026 quarterly deadlines are April 15, June 15, Sept. 15 and Jan. 15, 2027.

For taxes paid through withholding, the 90% threshold is a “safe harbor” that can prevent penalties even if income is uneven. For estimated taxes on other income, the 90% often should be paid in four equal installments. This can be hard if income is variable.

Make use of other safe harbors

Another safe harbor protects filers who pay 100% of their prior-year tax by the deadline if income is $150,000 or less, or 110% if it’s more.

Be careful: To deflect penalties, safe-harbor amounts should be paid quarterly in equal installments. If a filer pays all the prior-year tax in the third and fourth quarters, penalties would likely apply.

This provision can prevent penalties even if income balloons. Say that someone owed $50,000 of taxes for 2024 and paid $55,000 (110%) in equal installments during 2025. Even if this filer had a taxable windfall in 2025 and will owe $100,000 of tax on April 15, there would likely be no underpayment penalties due to the safe harbor.

Fight undeserved penalties

The IRS’s computers can impose unwarranted penalties because they treat income as if it’s earned equally throughout the year. Say that someone does a Roth IRA conversion or receives large fund payouts in the fourth quarter and pays the correct tax at that time. The system will likely assume the income was earned equally during the year while tax was paid only in the fourth quarter—and impose a penalty.

Filers often can avoid or reduce these penalties by filing Schedule AI of Form 2210, which details when income was earned and taxes paid during the year. But it’s often easier to use a safe harbor.

The IRS will typically waive estimated-tax penalties for many filers who recently retired or became disabled, among other things. To request a waiver, follow the instructions on Form 2210.

Look to withholding

Many filers—especially retirees—have income that qualifies for withholding as well as income that doesn’t. Taxable withdrawals from traditional IRAs and similar plans, pensions, Social Security payments and employee bonuses are all eligible for withholding.

Such income has a great benefit: The law considers withheld taxes to come in evenly throughout the year, even if they don’t.

As a result, some investors don’t pay any estimated taxes during the year. Instead, they make a taxable IRA withdrawal late in the year, when income is known. This way they have enough tax withheld to cover at least 90% of what they’ll owe, sidestepping penalties.

David Norton, a retired engineer in Florida with an inherited IRA and investment income, got tired of spending hours each quarter determining his estimated taxes. Now he makes a large IRA withdrawal each December and has 99% of it withheld. That covers most of his taxes and avoids estimated-tax penalties.

“Quarterly taxes are a headache,” he says. “This simple, once-a-year calculation would probably work for a lot of people.”

Source: WSJ