Beat The Estimated Tax Penalty with Strategic Withholding

The quarterly estimated tax payment dates for the year 2025 is till April 15 2025; June 16 2025 and January 15 2026. If you do not adhere to these dates the tax code penalizes you. Here is more to it.

The current penalty rate for underpaying the first payment on April 15, 2025, is 7 percent. You can’t deduct the cost of the penalty, so the true rate is higher. In the 37 percent tax bracket, the penalty cost is equivalent to 11.11% -or 1.59 times higher than 7 percent.

Got a penalty in Q1, you can’t fix the penalty with a big payment on January 15, 2026. You can use strategic withholding from a planned IRA rollover or from W-2 wages and bonuses to disappear the penalty, as we explain below.

Safe harbor rules

90 percent rule: There is no penalty when you pay at least 90 percent of your current year’s tax, as shown on your Form 1040, via timely estimated tax payments. Timely means that you pay your estimated tax at a rate no less than 22.5 percent of your current year tax by each of the four estimated tax payment deadlines.

100 percent rule: If your adjusted gross income (AGI) on your prior year’s return is $150,000 or less ($75,000 for taxpayers who are married, filing separately), there’s no estimated tax underpayment penalty when you pay at least 100 percent of the tax shown on your Form 1040 for the prior year via timely estimated tax payments at a rate no less than 25 percent for each quarter.

110 percent rule: If the AGI shown on your prior year return exceeded $150,000 ($75,000 if you use married-filling-separately status for the current year), you must pay 110 percent of the tax shown on your prior year return at a rate no less than 27.5 percent for each quarter to avoid the penalty.

Withholding solutions

Federal income tax withholding counts as estimated tax payments, spread equally across the four due dates-unless you can show when the withholding happened, in which case you can choose to treat it as paid on those specific dates.

Bonus Solution

On December 1, if you have shorted your estimated tax payments by $40,000. You operate your business as an S corporation and have the S corporation pay you a bonus of $47,000 and withhold federal income tax $40,000. Presto! The tax code applies $10,000 to each of your four estimates. Problem solved.

Not so fast. The added withholding solves the underpayment of estimated tax penalty, but it costs you and your corporation 15.3 percent in additional Social Security and Medicare taxes. You need to give this equation additional thought.

The IRA rollover and replace solution may be the answer.

Overcoming the W-2 job solution

You had $10,000 in withholding from your W-2 job during the first three months of the year. You need to make $40,000 in estimated tax payments for the year and plan to pay $10,000 in Q2, Q3 and Q4. So instead of letting the IRS automatically spread the $10,000 withholding evenly across all four quarters and creating a penalty for you in Q1, you identify if as a Q1 payment. Now each quarter shows a $10,000 payment. Problem solved.

IRA Rollover and Replace solution

Suppose you realize later in the year, that you are short of $40,000 in estimate tax payments. To fix this you take a $40,000 IRA distribution in December and request 100 percent withholding – to the entire $40,000 goes to the IRS. Within 60 days, you redeposit $40,000 back into the IRA, avoiding tax on the distribution. The $40,000 paid to the IRS is treated as tax withholding for the year and counts as if it were paid evenly across all four quarters. Problem solved.

Variation: You take the $40,000 on September 10 and apply it using the date-specific method. The $40,000 counts as an estimated tax payment on September 10.

Key point: IRC Section 3405(f) treats IRA withholding as wage withholding, so you the specific date method or the over the year method of applying the withholding to avoid the penalty for underpayment of estimated tax.

BergerCPAFirst, with over 30+ years of experience, offers comprehensive tax preparation services for individuals and businesses nationwide. Our commitment is to provide personalized attention while ensuring compliance and maximising tax benefits. If you have any questions or would like to schedule a consultation, please call (201) 587-9200 or send us an inquiry.

If you haven’t done so, create a formal reimbursement plan and submit expense reports. It is the right way to do business and the smartest way to keep more money in your pocket.

BergerCPAFirst, with over 30+ years of experience, offers comprehensive tax preparation services for individuals and businesses nationwide. Our commitment is to provide personalised attention while ensuring compliance and maximising tax benefits. If you have any questions or would like to schedule a consultation, please call (201) 587-9200 or inquire.