On April 30, Kitces posted an comprehensive article regarding the Tax Cuts and Jobs Act (TCJA) describing in detail where the congress is currently at and what steps are necessary to extend and/or change the the TCJA before the current tax law sunsets at the end of 2025.
I agree with the conclusion of the article to currently “wait and see” before taking action until I have a concrete expectation of what the individual income tax rules will look like in 2026. For me that means I plan to delay any traditional to Roth conversions and, as I have earned income for 2025, I will wait until 2026 to decide to fund any 2025 traditional or Roth IRA.
The one action I am doing is to have sufficient 2025 federal income tax and estimated tax payment paid in to protect us from the possibility of underpayment penalty based on the safe harbor rule determined using our 2024 adjusted gross income and 2024 tax liability.
Any other tax actions you are planning to take during 2025?
Bill, thanks for your post. About this paragraph:
The one action I am doing is to have sufficient 2025 federal income tax and estimated tax payment paid in to protect us from the possibility of underpayment penalty based on the safe harbor rule determined using our 2024 adjusted gross income and 2024 tax liability.
Is there some relationship between the safe harbor rule and what happens with the TCJA? My impression is that the safe harbor provision is something we estimated tax payers rely on every year regardless, but you have me wondering if I’m missing something?
Thanks as always for your expertise.
There is not a direct relationship between the safe harbor rules and what happens with the TCJA.
If the combination of the final tax rules, rates and brackets in 2026, my own actual taxable income for the rest of 2025 and the overall 2025 economic conditions causes me to accelerate income into 2025 or not to make 2025 tax deductible tax expenditures, like traditional IRA contributions for 2025, then I expect my 2025 tax liability will be higher. As such, I need to have made sufficient timely tax payments through a combination of federal withholding and estimated tax payments to avoid underpayment penalty.
The tax safe harbor rules for 2025 to avoid possible underpayment penalty are the following as I understand them-
If you owe a balance of less than $1,000 in tax for the current tax year after subtracting your withholding and refundable credits from your total current year tax liabilities then no underpayment penalty. Note any estimated tax payments are not included in this rule.
or
You expect your withholding, refundable credits and timely equal quarterly estimated tax payment to be more than the smaller of-
Then there is no underpayment penalty.
It is important to remember that federal income withholding is effectively deemed to have been paid equally throughout the year where estimated tax payments are paid when delivered to the IRS. I have avoided arguments with the IRS about when delivery occurred by paying my ES payments via direct pay from my bank account and getting immediate confirmation.
I expect one of the reasons others have commented about deciding to fund their tax payments through late in the year federal income tax withholding rather than estimated tax payments is avoiding underpayment penalties in our pay as you go federal tax system.
The underpayment penalty grows with the size of the shortfall between your tax liability and what you have timely paid in and the calculation is made on a quarterly basis (whose quarterly periods do not follow the calendar, think 4/15, 6/15, 9/15, EOY). See IRS form 2210 and instructions to determine if you meet one of the exceptions to all or part of the penalty. Alternatively, some taxpayers may choose to do nothing and the IRS will bill you for any underpayment penalty based on the information they already have after your return is filed. If you are using a professional tax preparer most software has a box to check to suppress calculation of the penalty and let the IRS calculate the penalty and bill you. You can instruct your preparer to check the box. The assumptions preparers make about when you actual pay the balance due with your 1040 can affect the actual underpayment penalty due so the payment date the preparer inputs or the default date of the due date of the return that most tax software use can and does cause differences in calculated penalty between the preparers calculation and the IRS calculation. IRS calculation wins.
Other exceptions to the underpayment penalty rules may apply such as if you live is a federally declared disaster area.
If you do not have a late in the year income source from which you can withhold income tax from, a payment of a sufficient estimated tax payment to meet the safe harbor rules will keep the underpayment penalty from growing larger but not eliminate it.
There are also other more complex exceptions to underpayment penalty based on factors such as when in the year you earn the income and also the taxpayer can determine when in the year their actual federal tax withholding (FWT) occurred and if a large part of your FWT occurred early in the year that may be beneficial to reducing the underpayment penalty.
If your income and actual withholding varied during the year and your penalty is reduced or eliminated when figured using the annualized income installment method you must figure the penalty using Schedule Al and file Form 2210. I can only recall a few times in my career as a preparer when the time and cost of using the annualized income method on form 2210 was justified by the reduction in underpayment penalty.
Writing this reminds me of why I always like to meet the tax safe harbor. I hope this helps.
Best, Bill
Bill, thanks for your very detailed reply and information.
We have no withholding and pre-pay exclusively via the quarterly estimated payments. I never try to predict with certainty what our current year taxes will be and instead always rely on making payments based on the prior year’s tax.