Estimated tax shortfalls call for the right midyear fix

A midyear projection shows that your client Enzo is headed for a balance due. As his tax professional, should you increase withholding, recommend an estimated payment or annualize his income? The answer depends on more than how much Enzo will have paid by Dec. 31; payment timing may determine whether the adjustment prevents an underpayment penalty.

For 2026, estimated tax installments are generally due April 15, June 15 and Sept. 15, 2026, and Jan. 15, 2027. Section 6654 imposes the underpayment penalty. Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, is used to determine whether a taxpayer meets a safe harbor, calculate any penalty when required, apply the annualized income installment method or request certain waivers.

Find the shortfall before choosing the fix

Project the client’s total 2026 tax liability, then subtract expected withholding, estimated payments and applicable refundable credits. Determine whether the client is on track to satisfy the current-year or applicable prior-year safe harbor.

A taxpayer generally avoids the penalty by paying at least 90% of the current-year tax or 100% of the prior-year tax. The prior-year threshold generally increases to 110% when the taxpayer’s prior-year adjusted gross income exceeded $150,000, or $75,000 for a married taxpayer filing separately. Also, no underpayment penalty generally applies if the taxpayer expects to owe less than $1,000 after subtracting withholding and tax credits.

Reaching a safe harbor based on total year-end payments does not automatically eliminate the penalty. The IRS also considers whether the taxpayer paid enough by each installment date. A client can reach 90% by year-end and still have an underpayment for an earlier period.

Give withholding the timing advantage

When the client has a practical withholding source, such as wages or retirement distributions, additional federal income tax withholding may offer a valuable advantage. Under §6654(g), withholding is generally treated as paid evenly on the four installment due dates unless the taxpayer establishes the actual withholding dates. Additional late-year withholding can therefore help address an earlier installment shortfall.

For an employee, calculate the remaining projected shortfall and divide it by the pay periods left in the year. The result may generally be entered as additional withholding in Step 4(c) of Form W-4, Employee’s Withholding Certificate. Allow time for payroll processing and account for bonuses or other irregular compensation still expected.

Estimated payments remain appropriate when the client lacks a withholding source or cannot adjust withholding promptly. Sole proprietors, investors, landlords and partners may make payments using Form 1040-ES, Estimated Tax for Individuals, through IRS Direct Pay, an IRS Individual Online Account, an existing Electronic Federal Tax Payment System (EFTPS) account or another approved payment method.

Unlike withholding, an estimated payment is generally credited when paid. A large fourth-quarter payment may reduce the balance due and stop further penalty accrual on the amount paid, but it ordinarily cannot erase an underpayment from an earlier installment period.

Uneven income may change the installments

Equal installments may overstate the required payment when income arrived unevenly during the year. A late-year business surge, investment sale, required minimum distribution (RMD) or bonus may make Schedule AI (Form 2210), Annualized Income Installment Method, worth considering.

The calculation must reflect when the client received income, incurred deductions and became eligible for credits, as well as when withholding and estimated payments were made during each annualization period. Dividing annual totals evenly across four periods will not support the calculation.

Depending on the client, the file may require period-specific profit and loss statements, payroll records, brokerage transaction histories, retirement distribution records and payment confirmations.

Schedule AI can reduce or eliminate a penalty, but the savings may not justify reconstructing incomplete records. Before beginning, confirm that the client can provide the required records and discuss whether the likely penalty savings justify the additional preparation fee. Document the decision in the file.

Take the shortfall strategy further

Midyear adjustments work best when the tax professional identifies the shortfall early and chooses a payment strategy that addresses both the amount due and the timing rules.

Register for the Preventing Underpayment Penalties with Mid-Year Adjustments on-demand webinar to work through withholding adjustments, estimated tax strategies, annualized-income calculations and the client records needed to support them.