The IRS wants you to pay your federal income tax deficit as you earn money during the year, either by withholding from your paychecks or through estimated tax payments. Pay much less and you risk having a sizable tax burden and an IRS underpayment penalty when you file your federated income tax return.
Pay-as-you-go is the style of taxation used in the United States, meaning that you must set aside or reimburse expected taxes as you get money. The IRS typically expects you to pay 90% of the total amount you owe for the ongoing tax year — or 100% of the tax shown on the prior year’s return, whichever is less — by the deadline for filing your consolidated return, which is often April 15.
If you end up paying less because insufficient tax was withheld from your salary or your monthly projected payments were incredibly low, the IRS may impose a charge to make up for the error.
Important aspects of the underpayment penalty, circumstances that could trigger it, and strategies to avoid it have all been covered in this piece. Continuity follows.
What does an IRS underpayment penalty entail?
The IRS may impose an underpayment penalty on taxpayers who fail to make timely tax payments through holding back or projected payments over the whole tax year. In an effort to encourage taxpayers to adhere to IRS laws, the IRS imposes additional fines.
If your total anticipated amount of withholdings (or both) do not fall below, you are subject to an IRS underpayment penalty.
Less than 90% of the tax owed for the current year was covered by the tax reimbursement total from the previous tax year. But to pay the correct amount of tax, you have to know your tax bracket and can use a tax bracket calculator to find the exact amount.
In the meantime, the amount you paid during the tax year did not even come close to covering 100% of the taxes you owed the previous year.
A penalty for underpayment might be assessed, for example, if your federal income tax burden for the current year was $10,000 and you were only refunded $8,000 (only 80% of your total tax deficit).
In any case, according to the IRS, you can avoid the penalty if the amount owed is less than $1,000 after deduction of refundable or withheld credits.
You might need to complete IRS Form 2210 if a penalty is appropriate. Usually, the IRS will calculate the underpayment penalty for you, but occasionally, you might have to estimate your penalty total on the form.
Procedure for Underpayment Penalties
People must pay 90% of the current year’s tax by combining anticipated and withheld charges with 100% of the tax from the prior year in order to avoid an underpayment penalty.
The IRS underpayment penalty is due if the taxpayer fails to pay the anticipated taxes in full or makes irregular payments throughout the tax year that result in an underpayment that is not deductible. Using IRS Form 2210, the total amount of taxes due is calculated after deducting the amount of estimated taxes already paid throughout the year. This form is quite different from other forms like the Form 1040.
The taxpayer must make up the shortfall if they realize they have underpaid the tax. A penalty is also calculated based on how long the money has been past due and the outstanding balance. The fine is not a certain percentage or a set sum of money. It relies on a number of factors, including the total underpayment fee and the period of unpaid taxes.
The decline-to-pay penalty, which is equal to 0.5% of the total amount due every month or part of a month the tax is overdue, is applicable to underpayments.
In what ways is the penalty waived?
In some situations, the IRS may waive the underpayment penalty.
Reasonable excuse for the penalty
The IRS may grant a valid cause penalty respite if you can prove that you did your best to pay your taxes on time but that circumstances beyond of your control prevented you from doing so. One or more of the following may qualify you for this penalty relief: you experienced a natural disaster, a death or serious illness in your immediate family, or some strange circumstances.
Aging or incapacity
The IRS may also postpone the underpayment penalty if you retired after age 62 or became disabled in the same tax year or the tax year prior and the non-payment was due to a valid reason.
Relaxation of the law
When a mistake is made, such as giving incorrect advice, the IRS may also decide to delay the underpayment charge. You might be granted the benefit of this form of penalty relief, for example, if an IRS representative verbally made an improper proposal to you.
Tax modification waiver
Some taxpayers were unsure of how much tax to pay because 2018 was the first year that the TCJA of 2017’s varied arrangements went into force. The IRS waived the underpayment penalties for any taxpayer who paid back around 80% of their total federal tax deficit before January 15, 2019. This happened for the 2018 tax year.
However, keep in mind that even while the IRS delays the underpayment penalty, you will still owe interest on the adjusted amount owed in taxes and may be required to submit Form 2210.
The best way to avoid all this process of filing a penalty is to be up to date with all your IRS forms and rules. If you find taxes hard to keep up with you can use a cutting-edge tax tool like Flyfin. This tool will help you file and pay your taxes correctly and timely and you can also read about company specific taxes like DoorDash taxes.
How can I prevent future IRS underpayment penalties?
Nobody wants to incur an IRS fee, but there are things you can take to prevent future underpayment penalties.
Improve your W-4 holdback
Depending on how much an employee makes and the information they provide on their W-4s, businesses are typically required to withhold taxes from that employee’s paycheck. You can create the tax shortage by altering your W-4 and asking your employer to withhold more money if they are not making enough cuts.
To determine how much your employer or firm should deduct from your paychecks, use the IRS’s withholding calculator. After that, complete the most recent Form W-4, which indicates how much you must deduct, and submit it to your employer.
Calculate your remittance
If you work for yourself or on the side, you may need to figure out and pay estimated tax payments throughout the year. Generally speaking, you are not required to hold and pay your tax debt in full at the conclusion of the tax year. Count the amount of your estimated charges and confirm that you are making regular estimated payments to avoid the underpayment penalty.
Present your yearly income
If your income is irregular or unpredictable, you might choose this option. With an accurate estimate of your profits over that time, you want to calculate your tax obligations. Consequently, annualizing your revenue can help you more accurately estimate your tax expenses if you run a recurrent business and the majority of your yearly income is concentrated in 3 consecutive months. Use this procedure by filling out Form 2210, organizing AI, and attaching it to your return.
The IRS can typically impose a fine if you do not pay enough tax that is past due during the year. The IRS lowered the threshold for the 2018 tax year to 80% of taxes due from qualifying taxpayers. If you are still disputing the IRS underpayment penalty, you may apply to have it waived by demonstrating good cause or by demonstrating that you were unable to determine your anticipated earnings.
Simply make sure you take the necessary precautions to avoid paying the penalty in the future by paying the IRS the correct amount throughout the year. If you are self-employed, you can do this by adding extra to your recurring anticipated tax payments or by asking your employer to withhold more from your earnings.