The underpayment penalty, and the safe harbour a gig driver can plan around

Federal income tax is meant to be paid as the money is earned, not once a year in April. An employee does that through withholding without thinking about it. A driver with no withholding does it through four estimated payments, and paying the whole year's bill in April, even in full and on time, can still cost an underpayment penalty for the months the tax was late.

What the penalty is

The underpayment penalty is a charge for not paying enough tax during the year through withholding and estimated payments. It is worked out on Form 2210, period by period, at an interest rate the IRS sets each quarter, so it behaves more like interest on a late payment than like a fine. It applies even when the return is filed on time and the balance is paid in full with it.

It is generally not charged when the balance due after withholding is under $1,000, and the annualised-income method can reduce it for a driver whose income arrives unevenly through the year. States have their own rules and their own penalties.

The safe harbour

Individuals generally avoid the penalty by paying on time, through the year, at least the smaller of two amounts: 90 percent of this year's tax, or 100 percent of last year's. The second figure rises to 110 percent of last year's tax when last year's adjusted gross income was over $150,000, or $75,000 if married filing separately.

The point of the second amount is that it is known in January. This year's tax is a forecast that moves with every payout and every deduction; last year's tax is a number on a return you have already filed. Paying a quarter of it each instalment is a plan whose penalty answer does not depend on how this year turns out. What it does not do is pay this year's bill. If this year's tax is higher, the difference is still due in April, without the penalty.

Two numbers, not one

That is why a driver's quarterly figure is really two figures. The safe-harbour instalment is the smallest amount that keeps the penalty away. The larger instalment, a quarter of this year's projected tax after withholding, is the amount that stops a balance building for April. In a year when driving income has grown, the two are far apart, and choosing the smaller one is a cash-flow decision to make knowingly rather than a discovery to make in April.

A driver with a W-2 job has a third route. Withholding counts toward both amounts, and the IRS treats it as paid evenly through the year regardless of when it was taken. Adding an amount on line 4(c) of a W-4 can retire the whole liability through payroll and replace four deadlines with one form.

• Safe harbour: the smaller of 90 percent of this year's tax or 100 percent of last year's, 110 percent for higher prior-year income.
• Owe nothing in April: a quarter of this year's projected tax after withholding, revisited during the year.
• Withholding counts toward both, and counts as if it were paid evenly.

How RoadKept handles it

RoadKept's quarterly screen shows both instalments, labelled, with the safe-harbour amount first. It takes last year's tax from the figure you enter off your return, never from an estimate, and it takes withholding from a payslip for the same reason. The projected figure is an estimate for planning, it moves as the year does, and the screen says so. Neither number is the IRS payment formula, and a preparer can apply the annualised method where uneven income makes it worth the paperwork.

A year of growth, two instalments

Last year's return showed $4,000.00 of tax on an adjusted gross income under $150,000.00, so the safe harbour is 100 percent of it. This year's driving is projected to owe $6,000.00. First with no withholding at all, then with a W-2 job that withholds $2,400.00 over the year.

Work it out from your own log — free

No card. Log a week and RoadKept shows the figure for your miles, at the right rate for each date.

Work it through with your own figures

The Quarterly Tax Calculator takes the numbers from your own log and does this arithmetic for you, free and without an account.

Questions drivers ask

Sources

• IRS Topic 306, Penalty for underpayment of estimated tax
• IRS, About Form 2210

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