The United States income tax is a pay–as–you–go tax, which means that tax must be paid as you earn or receive your income during the year. There are two ways to pay as you go. One is through tax withholding and the other is through estimated tax payments. Topic 355 provides information on paying estimated tax. If you do not pay enough tax through withholding or estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Most taxpayers will have paid enough tax to avoid this penalty if they have paid at least 90% of the tax shown on the return for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. However, if your adjusted gross income was greater than $150,000 in 2003, or $75,000 if you are married filing a separate return, the test is 90% of the tax shown on your 2004 tax return, or 110% of your 2003 tax, whichever is smaller. There are also special rules for farmers and fishermen.

Additionally, the payments must usually have been in approximately four equal amounts to avoid a penalty. However, if you made unequal payments because your income was received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income. Use Form 2210(PDF), Underpayment of Estimated Tax by Individuals and Fiduciaries, to see if annualizing would reduce or eliminate the penalty.

You will not have to pay a penalty for underpayment of 2004 estimated tax if your tax liability minus your withholding and credits is less than $1,000. The penalty also will not apply if you had no tax liability for 2003, you were a U.S. citizen or resident for all of 2003, and your tax year included all 12 months of the year. Also, the penalty may be waived if:

The estimated tax penalty is listed on line 75 of Form 1040(PDF) and line 48 of Form 1040A(PDF).

For more information, refer to Publication 505, Tax Withholding and Estimated Tax.