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Avoiding An Underpayment Penalty

A taxpayer receives a $40,000 capital gains distribution in December from a mutual fund. Assuming no estimated tax payments were made during the year and his only withholdings were from his W-2, what can the taxpayer do to avoid an underpayment penalty? How can this taxpayer avoid this situation in future years?

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IRC Section 6654(c)(2) states that estimated tax payments are due on April 15, June 15, and September 15 of the current tax year, as well as "January 15 of the following taxable year."

IRC Section 6654(d)(1)(B) states that "For purposes of [determining the penalty for underpayment of estimated income tax], the term "required annual payment" means the lesser of ...(i) 90 percent of the tax shown on the return for the taxable year (or, if no return is filed, 90 percent of the tax for such year), or ...(ii) 100 percent of the tax shown on the return of the individual for the preceding taxable year." Further, IRC Section 6654(d)(1)(C)(1) states that "If the adjusted gross income shown on the return of the individual for the preceding taxable year beginning in any calendar year exceeds $150,000, clause (ii) of subparagraph (B) shall be applied by substituting the applicable percentage for "100 percent". For purposes of the preceding sentence, the applicable percentage shall be determined in accordance with the following table: The If the preceding taxable applicable year begins in ... 2002 or thereafter [, the percentage is] 110. ... In the ...

Solution Summary

Extensively citing references, this solution discusses the conditions under which an underpayment penalty applies and offers tax planning solutions to avoid it in the current and future tax years.