The Internal Revenue Service has penalties for taxpayers who underpay their taxes. The underpayment penalty rate applies if a taxpayer pays less than 90 percent of tax liability.
This is the same whether the tax payments made through the tax withheld by an employer or the estimated tax payments. Regardless of the type of tax payment, the taxes paid during the course of the tax year must be at least 90 percent of the tax owed for that year.
If the taxes paid is under that, the underpayment tax penalties will apply. Here is an example of the underpayment tax penalty. Assume you owed the IRS $5,000 for the 2020 tax year and you got your W-2 Form from your employer and the federal income tax withheld from your income is $4,000. It means you’ve paid 80% of your tax liability. Now, you’re subject to the underpayment penalty as a result.
Exemption from Tax Penalties
However, the prior year’s taxes paid also plays a role here. If the tax paid this year sufficiently meets the tax liability of the prior tax year, you won’t pay underpayment penalties. If the taxpayer had no tax liability for the prior tax year, the penalties also don’t apply. That said, if the taxes owed last year was $4,000, you won’t be subject to underpayment penalties whereas if the tax withheld this year was under $4,000, you would pay penalties.
In the case of the underpayment tax penalty rate, it’s adjusted earlier in 2020. The underpayment penalty has been reduced to 3 percent of the unpaid tax. In the given example above, the underpayment penalty would be $30.
Underpayment penalty rate as of now is 3 percent of the unpaid tax.
Since underpayment can make you unable to pay taxes if you don’t have the funds to pay off tax liability and added with the penalties, it’s definitely something you should avoid. You can use our tax calculator to see if you’re going to owe the IRS or get a refund by entering a series of simple information about your income and anticipated tax return.