How to does the IRS Underpayment Penalty work for taxpayers?

By | October 5, 2013

Generally, failure to make proper estimated payments penalty is rarely assessed unless on pattern cases. Literally, most people self assess it, or their accounting software does, and if you do so and are correct about it the IRS won’t argue the point.


Calculating IRS Underpayment Penalty

When you calculate the amount of tax that you owe, after you’ve subtracted however much you had withheld or paid in estimated tax throughout the year, if you haven’t paid in enough tax, the IRS will assess a penalty for underpayment. This penalty is based upon the lesser of two amounts:

  • 90% of the amount of tax you will pay in total for the year;
  • or 100% of the amount of tax you paid for the previous year.

If you’re in the same boat next year, you may get assessed the penalty if you don’t correct your withholdings AND you are unable to fully pay by April 15th.


How to does the IRS Underpayment Penalty work for taxpayers?

You find this information from this IRS in Topic 306 Penalty for Underpayment of Estimated Tax. The United States income tax is a pay-as-you-go tax, which means that you must pay tax as you earn or receive your income during the year. You can do this either through withholding or by making estimated tax payments.


Estimated Tax Penalties

The IRS’ general rule on estimated tax payments is that, to be timely and avoid a penalty, the tax on money earned in:

  • January through March needs to be paid by April 15 of that same year
  • April through May needs to be paid by June 15 of that same year
  • June through August needs to be paid by Sept. 15 of that same year, and
  • September through December needs to be paid by Jan. 15 of the next year.

A lot of penalties are skipped because they aren’t worth the effort. People that technically should be getting a small bill, don’t. There are thresholds though I’m not allowed to share them specifically. Certain amounts are just written to 0 without any further need or care to waste resources trying to collect on it.

TurboTax will often assess the penalty so you may want to ensure it doesn’t. Technically you can be correct if you self assess and owe over $1,000. The IRS will not dispute your penalty. However, if you self assess even accidentally AND are correct in the amount, you can’t get it removed.

Most tax software is going to err on the side of caution and assess the penalty so that the end user pays everything and doesn’t get a surprise later. Generally, taxpayers should make estimated tax payments in four equal amounts to avoid a penalty. However, if you receive income unevenly during the year, you may be able to vary the amounts of the payments to avoid or lower the penalty by using the annualized installment method.


IRS Tax Forms Related to Underpayment Penalty

Use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to see if you owe a penalty for underpaying your estimated tax. The IRS has Form 1040ES to help you determine the amount of tax that you should be withholding or making in estimated payments.