The IRS underpayment penalty is charged when taxpayers fail to pay enough of their tax liability throughout the year, either through withholdings or estimated tax payments. The penalty is assessed if the taxpayer’s payments fall below a certain threshold by the time they file their tax return.
The IRS requires taxpayers to pay at least:
- 90% of the current year’s tax liability, or
- 100% of the previous year’s tax liability (110% for higher-income taxpayers).
If the taxpayer’s payments are below these thresholds, they may be subject to an underpayment penalty. The penalty is calculated based on the amount of the underpayment and the number of days it remains unpaid, with interest accruing over time.
Taxpayers can avoid the underpayment penalty by:
- Ensuring that enough tax is withheld from their wages through Form W-4 adjustments.
- Making quarterly estimated tax payments if they have significant non-wage income, such as self-employment income, investments, or rental property income.
In certain cases, taxpayers can request a waiver of the penalty if they can demonstrate that the underpayment was due to unusual circumstances, such as a natural disaster, or if they retired or became disabled during the tax year.
By carefully managing their withholdings and estimated payments, taxpayers can avoid the underpayment penalty and reduce their risk of owing additional taxes when they file their return.