Estimated Taxes and the Safe Harbor Rules: A California Owner's Guide

Every year, usually right after a good quarter or a big transaction closes, a client asks some version of the same question: my income is up this year, do I need to start paying estimates? And what happens if I just wait and pay it all in April?

The answer is almost never "you must pay in every dollar as you go." It is closer to "there is a floor you have to clear, and once you clear it the IRS and the FTB stop charging you." That floor is the safe harbor. Understanding it is the difference between guessing four times a year and knowing exactly what you owe and when.

Why estimated taxes exist at all

The U.S. tax system is pay-as-you-go. If you are a W-2 employee, your employer handles that through withholding on every paycheck. If you own a business, take K-1 income, sell property, exercise options, or live off investments, nobody is withholding for you. Estimated tax payments fill that gap.

If you do not pay enough during the year, you do not get in trouble in the criminal sense. You get charged an underpayment penalty, which is really just interest on the money you should have sent in earlier. The IRS rate floats with the federal short-term rate plus 3 percentage points and is compounded daily. California charges its own separate penalty at its own rate.

The federal safe harbor

You avoid the federal underpayment penalty if your total payments for the year, meaning withholding plus estimates, are at least the smaller of:

90% of your current year tax, or
100% of your prior year tax (110% if your prior year adjusted gross income was over $150,000, or over $75,000 if married filing separately)

That second option is the one most people miss. It is based on last year's number, which you already know. It does not care how much money you make this year. You could triple your income and still owe zero penalty, as long as you paid in 110% of last year's total tax on schedule.

There is also a de minimis rule: no federal penalty if you owe less than $1,000 after withholding and credits.

Federal due dates for the 2026 tax year:

Installment	Income period	Due date
1	Jan 1 to Mar 31	April 15, 2026
2	Apr 1 to May 31	June 15, 2026
3	Jun 1 to Aug 31	September 15, 2026
4	Sep 1 to Dec 31	January 15, 2027

The California safe harbor, which is not the same

California follows the same general structure but changes three important things.

1. The installment schedule is front-loaded. California does not want four equal payments. It wants:

Installment	Percentage of the year's required amount	Due date
1	30%	April 15
2	40%	June 15
3	0%	(no payment)
4	30%	January 15

By June 15, California expects 70% of the year's required estimated tax. Clients who send four equal checks are underpaid on the first two installments and get a penalty even though the annual total is right.

2. The prior year option disappears at $1 million. If your California AGI is $1,000,000 or more (or $500,000 if married filing separately), you cannot use the prior year safe harbor at all. You must pay 90% of the current year tax. This catches people in the year they sell a business or a property, and it catches them again the following year if income stays high.

3. High-income taxpayers must pay electronically. Once you make an estimated or extension payment over $20,000, or file a return with a total tax liability over $80,000, California requires all future payments to be made electronically. There is a 1% penalty for paying by check after that.

California's de minimis threshold is $500 ($250 if married filing separately), and no estimates are required if your prior year tax was zero for a full 12-month year of California residency.

Example 1: income jumps, and the prior year safe harbor saves the day

Maria is a marketing consultant in San Luis Obispo. In 2025 her total federal tax was $60,000 and her California tax was $22,000. Her 2025 AGI was $310,000, so the 110% rule applies.

In 2026 she lands a much larger contract and her income roughly doubles. Her actual 2026 federal tax will come in around $150,000.

She has two ways to avoid the penalty:

90% of 2026 tax: $135,000, except she does not know that number until the year is nearly over.
110% of 2025 tax: $66,000, a number she knows on January 1.

She pays $16,500 per federal quarter, $66,000 total. In April 2027 she writes a check for the remaining $84,000. No underpayment penalty. She kept the use of that $84,000 all year.

On the California side her required amount is 110% of $22,000, which is $24,200. Split California-style: $7,260 by April 15, $9,680 by June 15, nothing in September, $7,260 by January 15.

The tradeoff is cash discipline. She has to actually have the $84,000 in April. The safe harbor prevents a penalty, it does not prevent the bill.

Example 2: the same facts, but she crosses $1 million in California

Now assume Maria's 2026 income is not just up, it is up because she sold her practice, and her California AGI lands at $1.4 million.

Federally, nothing changes. The 110% of prior year safe harbor still works, so $66,000 of federal estimates still protects her.

In California it breaks. Because her current year California AGI is over $1 million, the prior year option is unavailable. She must pay 90% of her actual 2026 California tax. If that tax is $130,000, she needs $117,000 in during the year, front-loaded 30/40/0/30. Paying $24,200 and settling up in April produces a real penalty on roughly $93,000 of underpayment.

This is the single most common estimated tax mistake we see in California, and it almost always shows up in a sale year.

Example 3: the income arrives in December

David is an engineer with steady W-2 wages. In October 2026 he exercises non-qualified stock options and recognizes $400,000 of income. His prior year tax was small, so his prior year safe harbor is small, and he clears it easily.

But suppose he wanted to use the 90% of current year test instead. The quarterly system assumes income is earned evenly, so it would look like he underpaid the April and June installments even though he had no idea the income was coming.

Two fixes:

The annualized income installment method. Form 2210 Schedule AI federally, FTB Form 5805 for California, lets you match required payments to when income was actually earned. It requires real bookkeeping, but it eliminates penalties on lumpy income.
Withholding, which is treated as paid evenly across the year no matter when it happens. A December withholding increase from a paycheck, a bonus, or an IRA distribution with heavy withholding elected can retroactively cure earlier quarters. An estimated payment made in December cannot do that. This is a genuinely useful trick and it is under-used.

What we tell clients to do

Know your prior year number. Total tax from the return, not the balance due. Multiply by 1.1 if your AGI was above $150,000. That is your federal floor.
Check the California million dollar test early. If a sale, exercise, or spike year is coming, the prior year safe harbor is gone and you need current year projections, not a rule of thumb.
Respect California's 30/40/0/30 schedule. Equal quarterly payments are the wrong answer here.
Decide deliberately whether to exceed the safe harbor. The floor prevents penalties. It does not prevent an enormous April bill. Some clients want to fund the whole liability as they go so April is a non-event. Others prefer to hold cash and pay the difference at filing. Both are fine. Choosing by accident is not.
Use withholding as a late-year repair tool. It is the only lever that works backward.
Adjust for the PTE election. If your S corporation or partnership pays the California pass-through entity elective tax, your flow-through income drops and your personal estimates should drop with it. Owners who do not adjust overpay all year.

How this works on an advisory membership

For clients on a membership, this is not a spring conversation. We update the projection during the year, tell you what to pay and when, and recalculate when something changes: a sale closes, a distribution goes out, a big invoice lands. The point is that the April number should never be a surprise, and the safe harbor should be a decision rather than something you discover afterward.

If your income is up this year and you are not sure whether to start paying in, that is a fifteen minute conversation and it is worth having in the summer, not the following April.

Frequently asked questions

If I make more money this year, do I have to pay estimates on the new income?

Not necessarily. If you pay in 100% of last year's tax (110% above $150,000 of AGI) on schedule, you are protected from federal penalties regardless of how much your income grew. You will still owe the balance at filing.

Is the underpayment penalty deductible?

No. It functions as interest, but it is a nondeductible personal penalty for individuals.

What if I miss a quarter?

Pay as soon as you can. The penalty accrues per installment and per day, so a late payment costs less than a skipped one. There is no all-or-nothing cliff.

Can I just increase my W-2 withholding instead of paying estimates?

Yes, and in many cases it is better. Withholding is treated as if it were paid evenly across the year, which protects earlier installments retroactively.

Do I need to pay estimates in my first year of business?

If you had a prior year tax liability, use it as your safe harbor. If your prior year tax was zero for a full 12-month year, no estimates are required, but plan for the actual bill.

Does California ever waive the penalty?

Yes, in limited situations including casualty, disaster, retirement after age 62, or disability, where the underpayment was due to reasonable cause and not willful neglect. It is requested on Form 5805.

This article is general information, not tax advice for your situation. Federal rules are in IRC section 6654 and IRS Publication 505; California rules are in R&TC sections 19136 and 19025 and FTB Form 5805 instructions. Thresholds and rates change, so confirm current figures before acting.