IRS Penalty For Underpayment – The 2021 Ultimate Guide

We all hate paying taxes – there’s just something so viscerally wrong with seeing your hard-earned money go elsewhere. However, Uncle Sam always gets his cut – and underpaying your total tax (or miscalculating your estimated payments) – can lend you in trouble with the tax system.

It’s important to pay enough tax – or you’ll be hit with an underpayment penalty. This is a penalty relating to your federal income tax filing and can be issued for any previous tax year.

Last year’s tax return can be hit with an underpayment penalty – and in case you haven’t heard – the IRS really takes no prisoners, when it comes to collecting taxes.

What Is The Underpayment Penalty?

If you pay less than you owe to the IRS, you will find yourself on the wrong end of an underpayment penalty. If you don’t pay enough tax, the IRS charges any and all taxpayers – which ends up costing you more than if you had just followed the proper IRS rules to begin with.

This penalty applies if you paid less than 80% of what you owed to the IRS – as this is basically unpaid tax. This unpaid tax needs to be rectified, and properly paying your tax bill keeps you out of legal hot water.

You can also incur this penalty if you didn’t pay 100% of what you owed to the IRS last year. However, if you were only off by a small amount (anything less than $1,000) – the IRS says you can likely avoid the underpayment penalty.

It’s important to pay the proper amount of taxes for the current year – as well an the prior year. The longer you go without paying the proper amount of taxes, the more you will owe to the IRS.

If you are caught in this penalty, you will have to file IRS Form 2210. The IRS usually calculates your underpayment penalty, but rarely you may find yourself calculating the proper penalty amount on a tax worksheet.

Can I Get The Underpayment Penalty Waived?

While they won’t always waive the underpayment penalty, there are some situations where the IRS will acquiesce on this penalty. Here are a few situations where they may do so.

Reasonable Cause Penalty Relief

If you can show that you did your best to pay your taxes, but there were extenuating circumstances – the IRS may grant you what is called reasonable cause penalty relief. This can happen due to natural disasters, deaths, serious illnesses, or other strange occurrences.

Retirement And Disability

If you retired or became disabled, the IRS may waive the underpayment penalty. However, these cases are rare, and to properly retire, you must be over the age of 62.

Administrative Relief

This type of relief is more rare, but it can occur. Essentially, if someone from the IRS gave you the wrong tax advice, you may qualify for administrative relief – which will waive the underpayment penalty.

Tax Reform Waiver

Recently, the IRS changed the provisions of some parts of the tax code. This left many confused as to how much they needed to pay.

If you were caught up in a situation like this, you may qualify for a tax reform waiver. This waives an underpayment penalty, but it is pretty rare to qualify for one of these, in the real world.

The Difference Between A W-2 And A W-4

There are two important forms to consider when making proper IRS tax payments. The first is a W-4, which you give to your employer to properly withhold taxes from your paycheck.

A W-2 is the next relevant document, as it accurately reports what an employer paid you. It also shows the correct amount of money that they withheld from your paychecks.

How Can I Avoid The Underpayment Penalty?

No one likes IRS fines, so you can follow some steps to avoid the underpayment penalty in the future. If you’re self-employed, you should pay extra close attention to this section.

Try Adjusting Your W-4 Withholding

If you are worried your employer isn’t taking out enough from your paycheck, simply adjust your W-4 form, and ask for them to take out more. There are online calculators which help you estimate how much needs to be withheld from each paycheck, so this task becomes very easy to complete.

Try Making Estimated Payments

If you run your own business, taxes can be especially challenging. If you are self-employed, you should calculate your taxes throughout the year, and even make estimated tax payments.

This will help you lower your tax liability, as well as avoiding a giant tax payment all at once. One trick that is especially useful in avoiding the underpayment penalty, is to calculate the cost of estimated payments, and every quarter make sure these estimated payments go through to the IRS.

Try Annualizing Your Income

If you are unsure what your income may be for certain time periods, you can try annualizing your income. One example of this would be a seasonal business, where you want your tax payments to be as accurate as possible.

Interestingly, for many of these businesses, you can make almost all of your income in 3 or 4 months – which could potentially wreak havoc on your tax payments. For example, if you make all of your income in the fourth quarter, annualizing your income can help even out your tax payments for the year.

There is a specific form used by the IRS, Form 2210, which is perfect for situations like this.

Other Factors To Consider, Regarding Underpayment Of Taxes

It’s crucially important to make sure you file your income tax return accurately. You need to calculate your previous year’s gross income – and make sure it’s turned in by the proper IRS due date.

Underpaying your taxes is never a good idea – you can end up owing last year’s tax and this years – leading to a huge amount of tax due. And, of course, the higher your taxable income – the more you have to pay Uncle Sam.

Tax withholding is never a good idea – you might temporarily have more money in your pocket, but if you incur an IRS penalty – you’ll actually owe more. If you run your own business, be sure to properly report your self-employment income with the IRS.

There is a self-employment tax category, which has different rules than a big corporation does. No matter your filing status, underpayment of your taxes can result in big penalties.

The Bottom Line On Underpayment Of Taxes

We can sum it up very succinctly – pay your fair share of taxes owed, or face a penalty from the IRS. In recent years, the IRS lowered the threshold to 80% of your taxes owed – increasing the margin of error before you face a penalty.

If you still have an underpayment penalty, you can still try to get it removed, by showing reasonable cause or show roadblocks in the ability to accurately calculate your taxable income.

One trick to avoid underpayment of taxes if you’re self-employed is to add more to your estimated tax payments (which should be quarterly). If you have an employer, ask them to withhold more from your paycheck, so the IRS does not impose a penalty on you again.


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