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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 10163
Experience:  Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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I received a class action lawsuit payment early retirement

Customer Question

I received a class action lawsuit payment for an early retirement plan of $30k (backpay) and $800 month 2 weeks ago. Since this is considered income, will I be assessed a penaly for underpayment when I file for 2015 taxes? How would I make a payment now to avoid this penalty? My annual salary is about 150k, married, no dependents.
Submitted: 1 year ago.
Category: Tax
Expert:  Lane replied 1 year ago.

Hi,

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The way to avoid an underpayment penalty is to make estimated payments

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Here's the voucher for that: http://www.irs.gov/pub/irs-pdf/f1040es.pdf

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ON the underpayment penalty, generally, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and estimated tax payments, or if they paid at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller

Expert:  Lane replied 1 year ago.

So if you can go ahead an make estimated payments now ... and they (and your other withholding) get you to within 1000 if your actual tax liability, you won't HAVE an underpayment penalty

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And again, getting to 90% of this year's tax OR 100% of last years tax, (which might be the case here) there'll be no penalty

Expert:  Lane replied 1 year ago.

You can read more about the underpayment penalty from IRS here: http://www.irs.gov/taxtopics/tc306.html

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Please let me know if you have questions

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Lane

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Expert:  Jax Tax replied 1 year ago.

The following is INCORRECT

So if you can go ahead an make estimated payments now ... and they (and your other withholding) get you to within 1000 if your actual tax liability, you won't HAVE an underpayment penalty

Please allow me to assit without copy and pasting the results from a Google search.

First, the above statement is incorrect as such determination of owing less than $1000 is based on timely ES payments. If true the statements makes ES payments unnecessary as one could just pay all tax on Dec 31st en siringa to owe less than $1000 when filing. I will follow with a práctical answer that is correct

Expert:  Jax Tax replied 1 year ago.

To be clear the 100% 90% rules are based on tax liability which is the amount of tax assesed based on income not what you owe or have a refund for..The amount that is on the chart associated with your taxable income.

First, if you had a refund last year and your income and withholdings have not significantly changed, then you have likely had withheld from your w2 100% of last years tax liability. So there will be no penalty.

Expert:  Jax Tax replied 1 year ago.

If you owed some, then any penalty will be minimal as the penalty is based on how much of the ES payment was not made and your w2 withholdings count as ES payments.

This is what you should do to avoid penalties.

1. If you did not owe last year, as stated above and not much has changed with your job, you are fine. Just make sure come April 15 you can pay.

2. If you did owe last year, look at your return. The difference in your tax and your withholdings, should be paid asap using form 1040ES. You'll meet the 100% rule. Make sure come April, you have the money to pay.

Expert:  Jax Tax replied 1 year ago.

Lastly, if you do get a small penalty for 1st and 2nd Quarter 2015, pay the tax and file form 843 explaining the situation. If no other tax issues, the IRS generally gives a 1st time abatement of penalties and will also Consider your circumstances.

Expert:  Jax Tax replied 1 year ago.

It is unlikely the IRS penalize you for ES violations in year 1. They can but from a práctical standpoint they usually dont

Keep in mind April 15 is deadline to pay taxes. An extension covers only filings not payments.

Expert:  Lane replied 1 year ago.

I have a different different answer (and a reiteration of the original answer)

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(the idea that IRS will not charge the underpayment penalty in year one (whatever that means ... we don't have enough information to know what your history has been) is something that, in my 30 years experience, is not the case.

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And again, the idea that your refund or owing more at tax time has anything to do with your actual tax liability (total tax on line 63) is not how this works. ... Withholding and estimated payments either cover or don't cover your tax liability.

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Your tax liability is what it is (what you actually owe in taxes, based on income, deductions, exemptions, filing status, etc.) - when you calculate your taxes in April ... NOT whether or not you over withheld/estimated or paid so little throughout the year at tax time that you have this penalty.

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Again, there are essentially two ways to avoid the penalty (your intuition was good);

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(1) owe less than $1,000 in tax after subtracting their withholding and estimated tax payments.

(2) having paid-in at least 90% of the tax for the current year OR 100% of the tax shown on the return for the prior year, (again total tax liiability - line 63 of the 1040) whichever is smaller

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So it will either be ... (1) Going ahead and making the estimated payments to get you to (along with other withholding) within 1000 of what you'll actually owe OR (2) if your withholding and estimated get you to within 90% of this years tax OR 100% of Last years tax (not amount owed but actual tax liability (line 63) ... whichever is the smaller of theses two numbers in number (2) here (90% of this year or 100% of last year)... will get you there.

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That's the formula - I would not count on IRS simply waiving the penalty ..., not without your providing more information about your history.

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Please let me know if you have questions.... Sorry if this is not what you wanted to hear, but hopefully having all the facts will help you "see around some corners."

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I'll be here

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Lane

Expert:  Lane replied 1 year ago.

A little more information for you...

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Although I've seen more mistakes come out of H&R Block than any other tax prep firm (MAY be a volume issue), they have written a very good overview.

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From there:

The IRS uses this system to figure your penalty payment:

  1. When you file your return, the IRS calculates how much tax you should have paid each quarter.
  2. The IRS applies a percentage (the penalty rate) to figure your penalty amount for each quarter.
  3. The penalty amount for each quarter is totaled to come up with the underpayment penalty you owe.

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Then (as I mentioned above) there ARE exceptions

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There are exceptions to the penalty and situations where the penalty wouldn’t apply, including:

  • The total of your withholding and estimated quarterly tax payments was at least as much as your prior-year tax.
  • You had no tax liability last year, and you were a U.S. citizen or resident alien for the whole year.
  • You owed some tax last year, and you had that amount or more of tax withheld from your paychecks this year. However, if your adjusted gross income (AGI) was more than $150,000 -- or $75,000 if married filing separately -- you must pay at least 110% of last year's tax.
  • You had at least 90% of this year's tax withheld from your paychecks.
  • The amount you owe this year is greater than your withholding by no more than $1,000.
  • You didn’t have any withholding taxes, and your 2014 tax is less than $1,000.
Expert:  Lane replied 1 year ago.

And finally, just so you'll have this from the proverbial "horse's mouth," here's how IRS describes the penalty in Topic 306 - Penalty for Underpayment of Estimated Tax

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"

The United States income tax is a pay-as-you-go tax, which means that you must pay tax as you earn or receive your income during the year. You can do this either through withholding or by making estimated tax payments. If you do not pay your tax or you pay an insufficient amount of tax through withholding, you might also have to pay estimated taxes.

[...]

If you did not pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax.

[...]

Generally, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and estimated tax payments, or if they paid at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller.

[...]

There are special rules for farmers and fishermen, certain household employers and certain higher income taxpayers. Please refer to Publication 505, Tax Withholding and Estimated Tax, for more information.

[...]

Generally, taxpayers should make estimated tax payments in four equal amounts to avoid a penalty. However, if you receive income unevenly during the year, you may be able to vary the amounts of the payments to avoid or lower the penalty by using the annualized installment method. Use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to see if you owe a penalty for underpaying your estimated tax..."

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They can waive the penalty for casualty, disaster or other unusual circumstance, but simply receiving back pay would not satisfy the criteria.

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Hope this helps

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If this HAS helped, and you don’t have additional questions on this, your positive rating … (by clicking or touching the stars or smileys on your screen) … would be appreciated!That’s the only way I'll be credited a portion of what you've paid JustAnswer.

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