3. This year, Paula and Simon (married filing jointly) estimate that their tax liability will be $200,000. Last year, their total tax liability was $170,000. They estimate that their tax withholding from their employers will be $175,000. Are Paula and Simon required to increase their withholdings or make estimated tax payments this year to avoid the underpayment penalty? If so, how much?

When a taxpayer has an underpayment of estimated tax or fall behind on his/her tax prepayment, then he/she is required to pay a penalty on Form 2210. This penalty is called underpayment penalty.

According to the tax laws, Mr. P and Ms. S can avoid an underpayment penalty if their withholding's and estimated tax payments equal or exceed one of the following two safe harbors:

90 percent of current tax liability ($200,000 x 90% = $180,000) 110 percent of previous year tax liability (110% x $170,000 = $187,000)

From the above calculation, it is clear that Mr. P and Ms. S's withholding's ($175,000) do not equal or exceed the amount of two safe harbors. So, they need to increase their withholding's or make estimated payments to avoid underpayment penalty.

If Mr. P and Ms. S increase their withholding's by $5,000 or make estimated payments of $1,250

per quarter ($5000/4), they can avoid the underpayment penalty.

Mr. Paula and Simon average gross income is greater than $150,000, so 110% is taken.

yes they are required to increase their withholding tax by $5000

Explanation:

Paula and Simon will have to increase their withholding or make estimated tax payments to avoid underpayment penalty if the fall inside these two categories

current tax withheld for current year ≤ 90% of the current tax liability or

current tax withheld ≤ 110% of the previous year tax liability

current tax liability = $200000

last year tax liability = $170000

tax withheld = $175000

90% of $200000 = $180000: Is greater than tax withheld ($175000)

110% of $170000 = $187000 : Is greater than tax withheld ($175000)

To avoid underpayment penalty Paula and Simon should increase their withholding by at least $5000 or make estimated quarterly payments of $1250