CPA Exam — REG (Regulation)Federal Taxation of IndividualsHard
A taxpayer is required to make estimated tax payments. For the current tax year, their prior year's AGI was $180,000, and their prior year's tax liability was $30,000. They anticipate their current year's tax liability will be $40,000. What is the minimum amount of estimated tax they must pay to avoid an underpayment penalty, assuming they pay in four equal installments?
- A$36,000
- B$30,000
- C$27,000
- D$40,000
Show answer & explanationAnswer & explanation
Correct answer: C. $27,000
To avoid an underpayment penalty, taxpayers with an AGI over $150,000 in the prior year must pay at least 90% of their current year's tax liability or 110% of their prior year's tax liability, whichever is smaller. 1. 90% of current year's estimated tax: 0.90 * $40,000 = $36,000. 2. 110% of prior year's tax liability: 1.10 * $30,000 = $33,000. The taxpayer must pay the lesser of these two amounts, which is $33,000.
Why the other options are wrong
- A. This option represents 90% of the current year's tax, but the 110% of prior year's tax is lower.
- B. This option represents 100% of the prior year's tax, but the safe harbor for high-income taxpayers is 110% of prior year's tax or 90% of current year's tax, whichever is less.
- D. This option represents 100% of the current year's tax, which is not the minimum required to avoid penalty.
Estimated Tax Safe Harbors
Taxpayers can avoid underpayment penalties by paying at least 90% of their current year's tax liability or 100% of their prior year's tax liability (110% if prior year AGI was over $150,000).
- General rule: 90% of current year or 100% of prior year.
- High-income rule (AGI > $150,000): 90% of current year or 110% of prior year.
- Payments are typically made in four equal quarterly installments.
Memory trick: To avoid penalties, take the 'Safe Harbor' route for estimated taxes.