The IRS requires most taxpayers to pay taxes as they earn income through withholding or quarterly estimated payments. If you pay too little, the IRS imposes an underpayment penalty calculated at the federal short-term rate plus 3%, which is currently at 7% for 2026. That rate is applied to the underpaid amount for each day it remains outstanding.
There are some ways to avoid that penalty. The first is to pay 90% of your 2026 liability. Kinda hard to do, since you haven’t prepared your 2026 tax return yet, so you guess. If your guess turns out to be lower than 90% of your actual 2026 tax liability, then…you pay some underpayment penalty. The next way to avoid paying this penalty is to pay 100% (110% if your Adjusted Gross Income exceeds $150,000) of your 2025 tax liability. (Problem with this method, if 2025 was an odd-ball high income year, to avoid the penalty might be too expensive since you would be expecting your 2026 tax to be much less.) The final method is to pay 90% of your current annualized income. This requires computing your tax each quarter of 2026. This method is popular for folks who have seasonal income…not equal throughout the year.
I have quite a few clients who prefer to NOT pay any estimated tax or withholding, instead incurring the maximum penalty the following April. When the penalty comes to 7% of their actual 2026 tax liability, if the taxpayer can earn more than that, then it makes sense. Usually, businesses such as retail or manufacturing fit this group. They can reinvest a $1 multiple times in a year, rather than take it out of circulation in the form of a “loan” to the IRS at 0%.
2026 will be a difficult year to be able to estimate your tax liability. OBBA has a slew of new provisions, such as no tax on tips, no tax on overtime, the car loan interest deduction, and the enhanced senior deduction. Each of these needs to be updated on filing a new form W-4 with your employer. If you do not update your W-4, you may end up over withholding or under withholding. The expanded SALT cap and other itemized deduction changes can also significantly change effective tax rates compared to 2025.
Remember, the penalty is computed daily. If you missed making a quarterly payment, the penalty runs until you pay a catchup payment. Just paying the next quarterly installment does not stop the penalty running on the missed one.
One way to avoid the penalty is through income tax withholding. The IRS considers that to be paid equally throughout the year, regardless of when you actually pay it. If you missed a quarterly payment, have it made up through extra federal income tax withholding, then there is no penalty.
Have you heard? Psalms 32:7 says, “You are my hiding place. You will preserve me from trouble. You will surround me with songs of deliverance. Selah.”
— Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 775-882-4459. As well as on our website at BullisAndCo.com. You can also find us on LinkedIn and Facebook.
