Individuals who do not have enough tax withheld generally must make quarterly estimated tax payments. Under §6654, the underpayment penalty can generally be avoided by paying, on time, the lesser of 90 percent of the current year’s tax or 100 percent of the prior year’s tax, or 110 percent for higher-income taxpayers.
The Required Annual Payment
Under §6654(d)(1), the “required annual payment” is the lesser of:
- 90 percent of the tax shown on the return for the current year, or
- 100 percent of the tax shown on the return for the preceding year, if that year was a full 12-month year and a return was filed.
If adjusted gross income on the prior-year return exceeded $150,000 ($75,000 for married individuals filing separately), the prior-year figure is 110 percent instead of 100 percent (§6654(d)(1)(C)). The required annual payment is generally paid in four equal installments.
A taxpayer only needs to meet the lower of the two amounts. There is no requirement to pay the higher one.
An Example
For example, assume a taxpayer’s total 2025 tax was $40,000, 2025 adjusted gross income was $120,000, and 2026 tax turns out to be $58,000. The required annual payment for 2026 is the lesser of $52,200 (90 percent of $58,000) or $40,000 (100 percent of the 2025 tax), so it is $40,000, or $10,000 per installment. If those installments are paid on time, no underpayment penalty applies, even though $18,000 remains due with the return.
If the taxpayer’s 2025 adjusted gross income had been more than $150,000, the prior-year safe harbor would instead be $44,000 (110 percent of $40,000), or $11,000 per installment.
The safe harbor protects against the underpayment penalty, not against the tax itself. Any balance is still due with the return, and paying it by the return’s original due date avoids interest and late-payment penalties on that balance.
Why the Prior-Year Safe Harbor Is Useful
The current year’s tax is not known until the year is over, but the prior year’s tax is. For a business owner whose income is rising or hard to predict, paying 100 or 110 percent of the prior year’s tax in timely installments provides certainty about the penalty, with the remaining tax paid when the return is filed.
Federal Due Dates
According to the IRS, estimated tax payments are generally due:
- April 15, for income earned January 1 through March 31
- June 15, for income earned April 1 through May 31
- September 15, for income earned June 1 through August 31
- January 15 of the following year, for income earned September 1 through December 31
How the Penalty Is Computed
According to the IRS, the penalty is based on the amount of the underpayment, the period during which it was underpaid, and the published quarterly interest rates for underpayments. Because each installment has its own due date, a large payment late in the year does not necessarily avoid a penalty for earlier installments that were short.
Exceptions and Alternatives
Small balance. No penalty applies if the tax shown on the return, reduced by withholding, is less than $1,000 (§6654(e)(1)).
No prior-year liability. No penalty applies if the prior year was a full 12-month year, the individual had no tax liability for that year, and the individual was a U.S. citizen or resident throughout that year (§6654(e)(2)).
Waivers. The IRS may waive the penalty to the extent that, because of a casualty, disaster, or other unusual circumstances, imposing it would be against equity and good conscience. Relief is also available for taxpayers who retired after reaching age 62, or became disabled, in the year or the preceding year, if the underpayment was due to reasonable cause and not willful neglect (§6654(e)(3)).
Uneven income. A taxpayer whose income is concentrated later in the year may be able to reduce earlier installments using the annualized income installment method (§6654(d)(2)), computed on Form 2210.
California Estimated Taxes
California has its own estimated tax rules, and payments are made separately using Form 540-ES. According to the Franchise Tax Board’s 2026 instructions:
- Installments are 30 percent of the required annual payment for the first installment, 40 percent for the second, none for the third, and 30 percent for the fourth, with payment dates of April 15, 2026, June 15, 2026, and January 15, 2027.
- Taxpayers whose 2025 California adjusted gross income exceeded $150,000 ($75,000 if married or RDP filing separately) must use the lesser of 90 percent of their 2026 tax or 110 percent of their 2025 tax.
- Taxpayers with 2026 California adjusted gross income of $1,000,000 or more ($500,000 if married or RDP filing separately) must base their estimated tax on their 2026 tax, so the prior-year safe harbor is not available.
The Bottom Line
To avoid the federal underpayment penalty, it is generally enough to pay the lesser of 90 percent of this year’s tax or 100 or 110 percent of last year’s tax, in timely installments. California’s percentages, schedule, and high-income rule differ, so the state calculation should be done separately.
Questions about estimated taxes or penalties?
Tax attorney Cassra Minai, Esq. can review your situation in a confidential consultation.