Tax season can be daunting for many individuals and businesses, and the last thing anyone wants to encounter is the added burden of underpayment tax penalties. In this article, we’ll explain how this penalty occurs, how to avoid it, and ways you can reduce this penalty if incurred. Understanding the ins and outs can help you plan for tax time and avoid unexpected tax bills.
What is the underpayment of tax penalty?
There are two different types of underpayment tax penalties:
- Failure to Pay Penalty: This penalty is imposed when a taxpayer does not pay the full amount of taxes owed by the tax filing deadline. It is calculated based on the outstanding tax amount and accrues daily until the tax debt is fully paid.
- Estimated Tax Penalty: For taxpayers who are not subject to withholding tax, estimated tax payments are required. If these payments fall below the required amount, or if they are not made on time, an estimated tax penalty may be imposed.
How can I avoid an underpayment penalty?
To avoid an underpayment penalty, make sure you’re paying enough taxes throughout the year. One way to do this is by following the IRS Safe Harbor rule. This rule says you can avoid penalties if you pay either 90% of what you owe for this year or 100% of what you owed last year.
To stay on track, keep an eye on your income and adjust your payments if there are big changes. Regularly checking your tax withholding and making estimated payments can help you stay within these guidelines and avoid penalties.
Estimated payment dates 2025
| Payment Period | Deadline |
| April 1 to May 31 | June 15, 2025 |
| June 1 to Aug. 31 | Sept. 15, 2025 |
| Sept. 1 to Dec. 31 | Jan. 15, 2026 |
What triggers an underpayment penalty?
An underpayment tax penalty is triggered when an individual or business fails to pay enough in taxes throughout the year, resulting in an insufficient payment of their tax liability. It’s important to note that simply paying your full tax bill at the time of filing does not eliminate the penalty. The penalty is related to the timing of the payments throughout the year. If you don’t make adequate payments during the year, you could still be subject to this penalty, even if you settle your total tax bill when you file your return.
This penalty is designed to encourage taxpayers to stay current on their tax obligations and avoid potential tax underpayments in the future. If you owe an underpayment tax penalty, the IRS will send you a notice or letter.
How much is the penalty for underpaying taxes?
The amount of the underpayment of tax penalty can vary depending on several factors, including the amount of the underpayment, the period when the underpayment was due and unpaid, and the current penalty interest rate (published by the IRS quarterly).
In most cases, you won’t need to figure out this penalty on your own because the IRS calculates it for you. However, if you’re filling out Form 2210 , you’ll have to calculate the penalty yourself based on the amounts you owe and the time periods involved. This form will guide you on how to calculate the penalty and check if you can get any exemptions.
What are the reasons I may have underpaid my taxes?
There are several reasons why someone may find themselves facing underpayment tax penalties. One common reason is experiencing fluctuations in income or employment throughout the year, making it challenging to accurately estimate and withhold the appropriate amount of taxes.
Additionally, inconsistent tax withholding, either due to errors in W-4 forms or changes in payroll systems, can lead to unintentional underpayments. Anytime you experience a change in your financial situation you should check your W-4 to ensure you have enough withheld from your paycheck.
Unforeseen changes to tax deductions or credits, such as unexpected changes in family circumstances or eligible expenses, might also cause taxpayers to underpay their taxes.
Who is most at risk of an underpayment penalty?
There are a few groups of people who are most at risk for an underpayment penalty and should keep an eye on their taxes throughout the year to avoid any surprises during tax season.
Self-employed or freelancers: This group often deals with fluctuating income and may not have taxes withheld throughout the year, increasing the risk of underpayment penalties if estimated payments aren’t made.
Investors: Those with significant capital gains may not consider estimated tax payments necessary, leading to underpayment if gains are large and unexpected.
Employees with side hustles or Restricted Stock Units (RCUs): Additional income streams may complicate their tax situation, making it easy to underpay if proper tax planning isn’t in place.
Retirees: This group relies on fixed sources of income like pensions or Social Security, and some may have investment income. If they’re not careful and don’t account for taxes on those earnings, they might underestimate what they actually owe and get hit with penalties.
Can I reduce my penalty?
There are circumstances in which the IRS may reduce or completely relieve you of the underpayment tax penalty.
For example, if the underpayment resulted from circumstances beyond the taxpayer’s control and they made a reasonable effort to comply with tax laws, the IRS may waive the penalty. The IRS refers to this as the Reasonable Cause exception.
Underpayment penalties may be waived or reduced if your ability to pay taxes was significantly impacted by:
- Natural disasters
- Casualties
- Other unforeseen events
- Retirement after reaching the age of 62
- Disability during the tax year
Circumstances like reliance on a tax professional, lack of knowledge, mistakes, oversights, or lack of funds won’t qualify as a reasonable cause that allows for an exception to the penalty.
If you believe you qualify for an exception or can’t pay taxes by the deadline, refer to the IRS guidelines to understand how to apply for penalty relief and dispute the penalty.
