If you’re required to pay estimated tax payments, the IRS may charge an underpayment penalty if you pay too little, too late, or don’t have enough tax withheld from your income. Estimating quarterly tax payments can be tricky, but to avoid penalties, you’re generally required to pay either 100% of your previous year’s tax liabilities or 90% of your current year’s expected taxes—whichever is less.
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This article explains who may be subject to underpayment penalties, how the penalty is calculated, and how to potentially avoid it.
📌 Also Read: 30 Biggest Business Tax Deductions (Write Offs) for 2025
What Is an Underpayment Penalty?
The US tax system operates on a pay-as-you-go basis. Instead of paying your entire tax bill at the end of the year, you’re expected to pay taxes as you earn or receive income throughout the year.
- If you receive a W-2 income, your employer typically withholds federal and state taxes from your paycheck and submits them on your behalf.
- If you’re self-employed, you’ll generally need to make estimated tax payments four times a year— typically on April 15, June 15, September 15, and January 15. If a due date falls on a weekend or holiday, the deadline shifts to the next business day.
An underpayment penalty applies when individual or business tax payers underpay their quarterly estimated taxes, have insufficient tax withheld, or submit payments after the deadlines.
How Much in Penalties Will I Have to Pay?
The underpayment penalty is calculated based on how much was underpaid, how long the payment was late, and the IRS interest rate in effect during that period. The penalty is not a flat fee and varies depending on your specific circumstances.
In most cases, interest is charged at the federal short-term rate plus 3 percentage points. You or your tax professional can use Form 2210 to calculate the exact amount of your penalty.
In addition to interest, you may also owe a failure-to-pay penalty, which is typically 0.5 percent of the unpaid amount for each month it’s overdue, up to a maximum of 25 percent.
Who Is at Risk of Underpayment Penalties?
Anyone required to pay estimated taxes could be subject to the underpayment penalty.
You must make estimated tax payments if:
- You expect to owe at least $1,000 in taxes, after subtracting your withholding and tax credits, when you file your return.
- You expect your withholding and tax credits to be less than the smaller of:
- 90 percent of the tax to be shown on your tax return, or
- 100 percent of the tax shown on your 2024 tax return; 110 percent if your 2024 AGI is over $150,000 (must cover all 12 months of the 2024 tax year).
- You’re a W-2 employee but your employer isn’t withholding enough tax.
- You run a business or are part of a corporation, partnership, or LLC.
- You receive capital gains, dividends, rental income, or royalties
Estimated tax payments are most common among self-employed individuals, business owners, freelancers, investors, landlords, and corporations.
What Are the Exceptions?
Even if you fall into the categories listed above, you’re not required to pay estimated tax payments if:
✅Your estimated tax liability for the tax year is under $1,000.
✅All of the following apply:
- You had no tax liability for the previous tax year, meaning your total tax was zero or you didn’t have to file a return.
- You were a US citizen or resident alien for the whole current tax year.
- Your previous tax year covered a 12 month period.
How to Avoid Underpayment Penalties
There are two ways to avoid being charged with an underpayment penalty:
✅ Pay at least 90 percent of your current tax year’s tax liability through on-time estimated tax payments. The most effective way to do this is by using tax software, consulting a tax professional, or filling out Form 1040-ES to calculate your estimated tax.
✅ Pay 100 percent of the prior year’s federal tax liability or 110 percent if your adjusted gross income (AGI) was over $150,000. This is known as the IRS “safe harbor” rule. Even if your income increases, meeting this threshold typically allows you to avoid penalties.
How Will I Know If I Receive an Underpayment Penalty?
The IRS will notify you by mail if you owe an Underpayment of Estimated Tax by Individuals Penalty. The notice will include the amount owed and a breakdown of how the penalty was calculated.
How to Dispute an Underpayment Penalty
You may qualify for a penalty waiver or reduction if certain conditions apply:
✅ You retired after age 62 or became disabled in the current or prior tax year, and the underpayment was due to reasonable cause, not willful neglect.
✅ The underpayment was caused by a casualty, disaster, or other unusual circumstances, such as a serious illness, injury, or death in the family—events considered beyond your control.
If none of the above apply, you may still dispute the penalty if it was based on incorrect written advice from the IRS. All of the following conditions must be met:
- The written advice came directly in response to your written request.
- The advice did not result from omissions or errors in your request.
- You reasonably relied on that advice and were penalized as a result.
📌 Also Read: IRS | Underpayment of estimated tax by individuals penalty
Key Takeaways
Underpayment penalties can add unexpected costs if you don’t pay enough tax during the year.
To help avoid them, aim to meet the IRS safe harbor rules by paying either 90 percent of your current tax liability or 100 percent (or 110 percent, if applicable) of last year’s taxes.
If you’re unsure how much to pay or when, consider working with a tax professional or using IRS tools to estimate your payments accurately.
📌 For more tips on managing taxes and staying compliant, check out our other articles below:
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