Tax underpayment penalties can be an unexpected and unpleasant surprise for everyone from high-net-worth families to gig workers, but why do they happen and how do they work? This short guide reviews when underpayment penalties apply, how much one might owe, and how to avoid them. As always, this is the main reason it’s important to not avoid or ignore your quarterly tax payments!
What is a tax underpayment penalty?
The IRS has many types of penalties, such as harsh fees for failure to file, failure to pay (as in, any of your taxes), accuracy issues, dishonored checks, international reporting, and more. Underpayment penalties relate to not paying enough estimated tax throughout the year (for both individuals and entities).
When do underpayment penalties apply?
In the US, taxes are a pay-as-you-go system, and most people owe taxes as they earn. The average W-2 workers will pay via their withholding. Freelancers, self-employed workers, and many types of business entities will pay quarterly estimated payments throughout the year. Even W-2 workers may owe if they’re not withholding enough. Check out the IRS Tax Withholding Estimator to see how much you should be paying throughout the year.
Underpayment penalties will not apply if one of the following is true:
- You owe less than $1,000 in tax.
- You’ve paid your withholding or estimated tax on 90 percent of the tax for the current year or 100 percent of the tax shown on the prior year’s return, whichever is smaller.
If you’ve not made quarterly payments, the above factors don’t apply, and you expect to owe a significant amount, you might see a penalty.
How are underpayment penalties calculated?
The IRS uses your original tax return that you’ve filed before the due date to calculate the amount, but note that the IRS also charges their penalties with interest. As of 2025, the quarterly interest rate is 7 percent for underpayment penalties, which is high if an individual ignores these fees for a significant amount of time.
Do states charge underpayment penalties?
The severity of underpayment penalties varies wildly by state. For instance, Georgia has several kinds of underpayment penalties for entities and businesses, with rates significantly increasing for fraudulent underpayment. New York also will charge a penalty with interest on top of the federal government rates. California has those fees, plus an extra fee for LLCs.
How can you avoid underpayment penalties?
Firstly, you’ll want to understand if you’re expected to make estimated tax payments. You can connect with a professional accountant or use the IRS quiz to answer the question: Am I required to make estimated tax payments?
If you must pay estimated tax payments, the obvious way to avoid the penalty is to make these payments at the appropriate deadlines. These deadlines typically are the following:
- April 15 – For the period between January 1 and March 31
- June 15 – For the period between April 1 and May 31
- September 15 – For the period between June 1 and August 31
- January 15 – For the period between September 1 and December 31
Important Tips for Avoiding Tax Underpayment Penalties
- A frequent error is to confuse an estimated tax payment versus balance due when the taxpayer pays online. Balance due is typically for the amount owed in a yearly return for last year; estimated taxes are for the current year.
- Set reminders on your calendar for quarterly payments, as they easily slip by.
- Check your withholding during the year.
- Meet the “safe harbor” requirements of 110 percent of the taxes owed on the prior year’s return, 90 percent of the tax you owe in the current year.
- Connect with your professional accountant if you experience severe mid-year jumps in income.
What happens if I owe an underpayment penalty?
If you feel you’re likely to owe and missed a deadline, the IRS gives a specific path as to how to calculate underpayment penalties: Fill out Form 2210. This can help you prepare the calculation for how much you may owe.
The IRS may also issue a tax notice for missing payments, which may need to be addressed or disputed with the help of a tax professional.
