Why You Can Owe an Underpayment Penalty Even When You Pay Your Taxes: What You Need to Know for 2026
“Why am I being charged a penalty? I’m paying my taxes now.”
Or even more confusing:
“I’m getting a refund. How can I still have an underpayment penalty?”
These are common questions during tax season.
The reason is simple: taxes are supposed to be paid throughout the year, not just when you file your tax return.
If you work for an employer, taxes are usually taken out of every paycheck. You may not even think about it.
But if you are self-employed, own a business, receive investment income, sell property or stocks, or have other income without enough tax withheld, you may need to make estimated tax payments yourself.
If you don’t pay enough during the year—or don’t pay it on time—you may have an underpayment penalty.
You Can Pay Your Tax in Full and Still Have a Penalty
This is the part that often surprises people.
April 15 is generally the deadline to pay any remaining balance on your tax return. But that does not mean you can wait until April to pay all the tax you owed on income earned throughout the previous year.
Think of it this way:
If you earned income throughout 2026, the government generally expects you to pay tax on that income throughout 2026.
So there are really two separate questions:
Did you eventually pay enough tax?
Did you pay enough on time during the year?
An underpayment penalty is mainly about the second question.
California Has Its Own Payment Schedule
California’s estimated tax schedule is different from the federal schedule.
California generally divides your required annual estimated payment like this:
30% in April
40% in June
0% in September
30% in January
Yes, the September installment is generally zero under California’s standard schedule.
This is one reason you should not automatically use the same payment amounts and schedule for your federal and California estimated taxes.
How Do You Know If You’ve Paid Enough?
This is where the term safe harbor comes in.
It sounds complicated, but the basic idea is simple.
A safe harbor is a rule that tells you how much you generally need to pay during the year to avoid an estimated tax penalty.
For many California taxpayers, the calculation looks at:
90% of your current year’s tax, or
100% of your previous year’s tax
Special rules apply to higher-income taxpayers.
If your prior-year California AGI was more than $150,000 ($75,000 if married/RDP filing separately), you generally need to use 110% of the prior year’s tax instead of 100% when relying on the prior-year safe harbor.
What If Your Income Is $1 Million or More?
California has another important rule.
If your current-year California AGI is $1 million or more ($500,000 if married/RDP filing separately), you generally cannot use last year’s tax to determine your safe harbor.
Instead, your required payments generally must be based on 90% of your current-year tax.
Why does this matter?
Imagine you normally earn $200,000, but this year you sell a business or investment and your income increases dramatically.
Paying based only on last year’s tax may no longer protect you from an underpayment penalty.
That is why a major change in income should trigger a review of your estimated taxes.
When California Does Not Assess an Underpayment Penalty
There is an important exception that is easy to overlook.
If your prior-year California tax liability, after applicable credits, was less than $500 ($250 if married/RDP filing separately), you are generally not subject to the estimated tax underpayment penalty for the current year.
For purposes of this rule, estimated tax payments from the prior year do not reduce the prior-year tax liability used to determine whether you meet the $500/$250 limit.
Importantly, this exception can also apply even if your current-year California AGI is $1 million or more ($500,000 if married/RDP filing separately).
There is also a current-year threshold: you generally do not have to make California estimated tax payments if you expect to owe less than $500 after withholding and credits ($250 if married/RDP filing separately).
What If You Earn Most of Your Income at the End of the Year?
Here is another common situation.
Suppose your income is fairly low for most of the year. Then, in November, you sell an investment and have a large capital gain.
You could not have paid tax on that gain back in April because the gain had not happened yet.
California has a method that can help in situations like this. It is called the annualized income installment method.
Despite the complicated name, the idea is straightforward:
It looks at when you actually earned the income.
Instead of assuming that you earned the same amount throughout the year, the calculation considers your actual income during different parts of the year.
This may reduce or eliminate an underpayment for one or more installments when income was received unevenly during the year.
For individuals, the calculation is generally reported on California Form FTB 5805. Corporations generally use Form FTB 5806.
When Should You Review Your Estimated Taxes?
You do not need to recalculate your taxes every week.
But it is a good idea to review them when something significant changes.
For example:
Your business is making more money than expected
You start working for yourself
You sell stocks or other investments
You sell real estate or a business
You receive a large bonus
You receive significant partnership or S corporation income
Your withholding decreases
Your income increases substantially
These are situations where waiting until tax-return time can lead to an unpleasant surprise.
The Most Important Thing to Remember
An underpayment penalty does not necessarily mean that you didn’t pay your tax.
It may simply mean that you didn’t pay enough of it at the right time during the year.
That is why estimated tax planning matters.
If your income changes significantly during the year, don’t wait until your tax return is prepared to find out whether you paid enough. Reviewing your withholding and estimated payments earlier gives you time to make adjustments.
If you are unsure whether you are paying enough federal or California tax during the year, San Diego Precision Tax Service can help you review your estimated payments and determine whether adjustments may be needed.
General information, not tax advice.
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