How to Avoid IRS Tax Penalties for Underpayment

Introduction

The IRS requires taxpayers to pay taxes throughout the year, either through withholding or
estimated tax payments. If you underpay your taxes, you may face penalties and interest charges
under IRC § 6654.

Understanding how IRS penalties work and how to avoid them can help you reduce tax liability and
avoid unexpected charges. This guide explains why underpayment penalties occur, how to
calculate them, and ways to prevent them in 2025.

What Causes IRS Underpayment Penalties?

1. Not Paying Enough Taxes Throughout the Year

•  The IRS expects taxpayers to pay at least 90% of their total tax liability for the current year or 100% of last year’s tax liability (110% for high-income taxpayers).

•  If you fail to meet these thresholds, the IRS may charge an underpayment penalty.

2. Missing Quarterly Estimated Tax Payments

• Self-employed individuals, freelancers, and investors must pay estimated taxes quarterly
  using Form 1040-ES.
• Failing to make timely payments can result in penalties and interest charges.

3. Incorrect or Insufficient Withholding

• If too little is withheld from wages (Form W-2), retirement income (Form W-4P), or Social
  Security benefits (Form W-4V), you may owe taxes at the end of the year.

4. Underpaying Taxes on Investment or Business Income

• If you earn significant dividends, capital gains, rental income, or self-employment income,
  you need to calculate and pay estimated taxes to avoid penalties.

How to Calculate IRS Underpayment Penalties

Step 1: Determine If You Owe a Penalty

•  Use IRS Form 2210 to calculate underpayment penalties.
•  The IRS generally applies a penalty if you owe more than $1,000 in unpaid taxes.

Step 2: Calculate the Underpayment Amount

•  The penalty is based on the federal short-term interest rate + 3%.
•  The IRS applies penalties quarterly, so late payments increase penalties.

How to Avoid IRS Underpayment Penalties

1. Increase Tax Withholding

•  Adjust Form W-4 with your employer to increase federal tax withholding.
•  Use the IRS Withholding Estimator to ensure correct deductions.

2. Pay Quarterly Estimated Taxes on Time

•  Make payments using Form 1040-ES or IRS Direct Pay.
• Quarterly payment due dates:

3. Use the Safe Harbor Rule

• You won’t owe a penalty if you pay at least
• o 90% of the current year’s tax liability, or
• 100% of last year’s tax liability (110% if AGI is over $150,000).

4. Apply for a Penalty Waiver (If Eligible)

•  If underpayment occurred due to unforeseen circumstances (disability, disaster, or
  retirement), you may request a waiver using Form 2210.

IRS Forms & Compliance Checklist

•  Form 1040-ES – Pay estimated taxes
•  Form 2210 – Calculate and request waiver of penalties
•  Form W-4 – Adjust employer withholding
•  IRS Direct Pay – Make estimated tax payments online

Conclusion

Avoiding IRS underpayment penalties requires proper tax planning, estimated tax payments, and
accurate withholding adjustments. By using the safe harbor rule and paying quarterly taxes on
time, you can prevent penalties and stay compliant.

For expert tax assistance, schedule a consultation with Anshul Goyal, CPA EA FCA, a licensed tax
professional and IRS representative.

Frequently Asked Questions (FAQs)

1. How do I know if I owe an underpayment penalty?
If you owe more than $1,000 in unpaid taxes, the IRS may assess a penalty.

2. Can I avoid penalties if I pay taxes by April 15?
No, the IRS expects quarterly payments, not just one lump sum.

3. What if I miss an estimated tax payment?
Make the payment as soon as possible to reduce interest and penalties.

4. Can retirees owe underpayment penalties?
Yes, retirees must adjust withholding on pension income (Form W-4P) or pay estimated
taxes.

5. Does the IRS waive penalties for first-time underpayment?
Possibly, if you meet the IRS waiver criteria (Form 2210 required).

About Our CPA

Anshul Goyal, CPA EA FCA is a licensed Certified Public Accountant and an IRS Enrolled Agent (EA).
He specializes in penalty prevention, estimated tax planning, and IRS compliance.

Schedule a consultation today with Anshul Goyal, CPA, to avoid tax penalties and optimize your tax
strategy.