Estimated Taxes: How to Avoid an Underpayment Penalty

If you own a business, receive K-1 income, or have large investment income, tax is not withheld from much of what you earn. The IRS and California expect you to pay as you go through estimated tax payments. Pay too little or too late, and you owe an underpayment penalty, which works like interest on the shortfall.

The penalty is avoidable. The rules give you safe harbors, and knowing which one applies to you makes the year much simpler.

The federal safe harbors

For federal purposes, you generally avoid the penalty if your withholding and on-time estimated payments cover the smaller of:

• 90 percent of the tax on this year's return, or

• 100 percent of the tax on last year's return.

If last year's adjusted gross income was more than $150,000, or $75,000 for married couples filing separately, the prior-year figure becomes 110 percent instead of 100 percent. There is also a floor. If you owe less than $1,000 after withholding and credits, there is no federal penalty.

Most business owners rely on the prior-year safe harbor because it is based on a number you already know. If your income jumps this year, paying 110 percent of last year's tax on schedule still protects you from the penalty. You will owe the difference in April, but without a penalty on top.

Federal due dates

For 2026, federal estimated payments are due April 15, June 15, and September 15, 2026, and January 15, 2027. Each payment is generally expected to cover one quarter of the required annual amount.

One shortcut: if you file your 2026 return by February 1, 2027 and pay the full balance with it, you do not need to make the January 15 payment.

California's schedule is different

California uses the same idea on a different calendar. Its required payments are 30 percent by April 15, 40 percent by June 15, nothing in September, and the last 30 percent by January 15 of the following year. That puts 70 percent of the year's payments into the first six months. People who pay California in four equal installments are often short by June.

California's safe harbors mostly mirror the federal ones: 90 percent of this year's tax or 100 percent of last year's, rising to 110 percent when last year's AGI was over $150,000. There is one large exception. If your AGI for the current year is $1,000,000 or more, or $500,000 for married couples filing separately, you cannot rely on last year's tax. You must pay based on 90 percent of the current year's tax. For high-income owners, that means planning from a projection, not from last year's return.

California requires estimated payments when you expect to owe at least $500, or $250 if married filing separately, after withholding and credits.

Withholding can fix a late-year shortfall

Withholding gets special treatment. For federal purposes, tax withheld from wages is treated as paid evenly through the year, no matter when it was actually withheld. An estimated payment counts only from the day you make it.

That matters for S corporation owners on payroll. If you are behind in December, raising the federal withholding on your last paychecks of the year can cover shortfalls from earlier quarters. A January estimated payment is applied first to the earliest unpaid installment, but it stops the penalty only from the day you make it. The same approach works for anyone with a W-2 job, or a spouse with one.

When income arrives unevenly

Some years do not arrive in even pieces. A large sale in November, or a business that earns most of its profit late in the year, can make it look as if you underpaid early. The annualized income installment method lets you match your required payments to when you actually earned the income. It takes more work, because income has to be computed through each period, but it can reduce or remove a penalty when the income really did come late. California allows a similar calculation.

Setting payments for 2027

The cleanest approach is to set the year's payments in January using the safe harbor that fits, then review them at midyear when the books show how the year is going. For most owners, that means federal payments at the 100 or 110 percent figure and California payments on its 30-40-0-30 schedule. If you may be near California's $1,000,000 line, plan from a projection instead.

What to send us

Send us your payment confirmations as you make them, including payments made through IRS Direct Pay or your MyFTB account. Tell us about large one-time items when they happen, such as a property sale, a large bonus, or a big distribution from a business. And if your income is changing a lot this year, ask for a projection before the January 15 payment.

Book your planning call

If you want a projection before the last 2026 payments are due, book a time with our team at calendly.com/kirkcole/15-minute-meeting.

This article is general information, not tax advice for your situation. Tax rules change, and the right move depends on your facts.