In a perfect world, you would be aware of the precise amount of tax to deduct or withhold from each paycheck throughout the year in order to balance your books at tax time. Sadly, though, this is not often how things turn out. In reality, a large number of tax payers find themselves in the terrible position of underpaying their taxes and suffering the consequences. Know how to avoid Tax Underpayment Penalty in 2022.
Nobody enjoys having to pay taxes. However, putting off paying your taxes can result in you owing the Internal Revenue Service additional money in the form of interest and penalties. The penalty for underpayment is one of such charges. An underpayment penalty is a fine imposed by the Internal Revenue Service (IRS) on taxpayers who either fail to withhold enough money from their paychecks or pay their taxes on time. Individuals typically need to pay at least either 100% of the tax from the previous year or 90% of the tax from this year to avoid an underpayment penalty.
This post is for you if you’ve gotten an IRS underpayment notice or simply want to avoid underpaying your taxes. We’ll go through what an underpayment penalty is, when it applies, how to prevent receiving one, and other details. For additional information on underpayment penalties, go through the complete article.
Table of Content
- 1 Brief Overview of Tax Underpayment Penalty in 2022
- 2 Tips to Avoid Tax Underpayment Penalties
- 3 Exemptions of Underpayment Penalty
- 4 Ways to Calculate an Underpayment Penalty
- 5 Conclusion
- 6 Frequently Asked Questions
Brief Overview of Tax Underpayment Penalty in 2022
- Internal Revenue Service (IRS) underpayment penalties for individuals for the third quarter (Q3) of 2022 are 5% for individual underpayments and 7% for big business underpayments over $100,000. The federal short-term rate is added three percentage points to underpayment penalties. You can get more clarification with an example. Like, you would have underpaid your taxes by $3,000 if you due $5,000 in taxes for the year but only paid $2,000 in taxes.
- You would be charged an underpayment penalty because the sum is greater than $1,000 and you did not pay at least 90% of what you owed (unless you met other criteria for avoiding it). The fine would be equal to the short-term federal rate plus three percentage points. That rate would be 5%, or $150, for Q3 2022.
- An underpayment penalty is a monetary consequence levied by the Internal Revenue Service against a taxpayer who underpays or pays their taxes after the deadline. Taxpayers are responsible for making sure they pay the right amount of tax throughout the year, whether through estimated quarterly payments or payroll tax withholdings, and for making their payments on time.
- They will be obligated to pay the remaining balance of their tax bill, as well as perhaps an underpayment penalty, if the amount paid is insufficient to meet their tax obligation. Individual or corporate taxpayers who do not pay the full amount of their estimated tax and withholding due are subject to a tax penalty. To determine if they must disclose an underpayment and pay a penalty, taxpayers should refer to IRS Form 2210.
- It’s simple to end up with an unsatisfactorily low tax balance for the year. Even while salaried employees can choose to have taxes deducted from their salary, if you report the incorrect number of allowances on your W-4, you risk receiving less money than you are entitled to. Similarly, even if you correctly filled out your W-4, you can still end up underpaying taxes if you’re a salaried employee who made a lot of additional income throughout the year (for example, from investments).
- If you have a variable income as a self-employed person or freelancer, it’s much simpler to underpay your taxes. Non-salaried employees must make anticipated quarterly tax payments based on their income rather than having taxes withheld from their paychecks when they receive money. If you mistakenly calculate the incorrect amount of tax to pay or omit a payment, you may be subject to an underpayment penalty if you work for yourself or as a freelancer.
Tips to Avoid Tax Underpayment Penalties
Penalties for late payments can be very complex and costly. It’s simply preferable to prevent the headache of being assessed an underpayment penalty by following these advices:
1. Awareness of Due Dates
The following dates should be noted because failing to pay your anticipated quarterly taxes by the due date could result in penalties: June 15, July 15, September 16, and January 15 (of the following year). Keep in mind that if these days fall on a weekend or a holiday, they can differ slightly. The following business day will be the due date if this happens.
2. Estimate Your Tax Liability Accurately
The key to avoiding an underpayment penalty is accurately estimating your quarterly taxes. It may be tempting to cut corners or overestimate the work, but doing so can end up costing you more money in the long run. You’ll need the following information to obtain an accurate estimate:
- Adjusted Gross Income Anticipated
- Income Subject to Taxation
- For the Year’s Taxes, Deductions, and Credits
To figure out your estimated taxes, utilize Form 1040-ES. Don’t forget to submit your money by the previously specified due dates once you have your computations.
3. Try to Get a Payment Plan
You can apply for an IRS payment plan if you lack the money to pay your tax debt in full. This will not shield you from all fees, but it will allow you to pay down your tax debt over time while also lowering the amount of interest and fees you must pay. By allowing taxpayers to apply for a payment plan straight from the IRS website, the IRS has made this choice simpler than ever.
4. Punishments for other Payroll Tax
If you own a small business, you should be aware of additional consequences if your taxes are not paid on time or at all. These consist of:
- Penalties for withholding Taxes that are not paid (Payroll Taxes)
- Information Return Penalties
- Penalties for Failing to file a Return by the Deadline
- Penalties for Late Tax Payments
- Penalties for Filing Forms that are Incorrect and Result in Unpaid Taxes
- Financial Fines, Liens, Interest on Unpaid Taxes, and even criminal and civil sanctions are examples of penalties.
Exemptions of Underpayment Penalty
There may or may not be a real penalty if you underpay your taxes. Generally speaking, the following situations will spare you from an underpayment penalty:
- Your total tax obligation is below $1,000.
- At least 90% of the taxes due were paid by you.
- You had no tax debt the prior year.
- During the year the underpayment was made, you turned 62 and retired.
- Due to an emergency, a natural disaster, or a fatality, including those affected by the COVID-19 pandemic, you were unable to make payments.
- During the tax year when the underpayment was made, you were rendered incapacitated.
- Early in the year, the majority of your income tax was withheld.
- Regardless of whether you are eligible to have your penalty waived, depending on your individual circumstances, you can still be eligible for a reduced penalty (e.g., your income varies throughout the year).
- The restrictions for farmers and fishers are different, which is something else to keep in mind. If you work in one of these fields, speak with a CPA or tax expert for guidance on your particular circumstances.
Ways to Calculate an Underpayment Penalty
The amount of your underpayment penalty is calculated using a number of different variables. Your final penalty payment to the IRS will depend on the following factors:
- The Amount of the Unpaid Balance
- The deadline for making the Underpayment
- The current Interest Rate for a Quarter
Let’s dissect the procedure to demonstrate how underpayment penalties are determined:
Calculate the Underpayment’s Amount
Establish the underpayment amount first. You have two options for reviewing your financial records: either do it yourself or enlist the aid of a tax or accounting expert. The amount owed to the IRS that was not paid in full or on time is known as the underpayment. Let’s examine a brief illustration:
- Within the first three months, you spent $2,500.
- You made a $2,500 payment for the second quarter.
- For the third quarter, you paid $2,500.
- For the fourth quarter, you paid $1,000.
- This results in an annual total of $8,500.
Let’s assume that your whole tax obligation in this scenario was $10,000. In reality, you were required to pay $2,500 for the final quarter. There is a $1,500 gap because you only paid $1,000. This is the underpayment amount.
Verify Your Eligibility for an Exemption
There’s a significant chance you’ll have to pay an underpayment penalty if you find that you did not pay enough taxes for the year. There is a possibility that you will be granted an exemption, though. As a reminder, you can only be exempted in extremely limited situations, such as if you suffered a calamity, got disabled, or owed less than $1,000. Speak with a tax expert or accountant if you’re not sure whether your circumstances make you eligible for a waived or reduced penalty.
Verify the Current Interest Rates
Your IRS underpayment penalty is subject to interest, so it’s crucial to make the required payment as soon as you can. You should be aware of the following two rates when calculating interest:
- The short-term interest rate on federal debt
- The quarterly IRS rate
The quarterly rate is 3% for the quarter that starts on January 1st, 2022. From April 1 through 3, 2022, this rate will rise to 4%. 0.22% is the IRS’s short-term interest rate (as of March 2022). Remember that these figures can change, so before calculating your penalty, please double-check the most recent rates. The underpayment penalty interest rate is calculated by averaging the federal short-term interest rate and the quarterly rate. This equates to 3.22% at the aforementioned rates.
Let’s continue with the scenario and imagine that you owe $1,500 since you failed to pay enough in estimated taxes after the deadline of January 15. On January 30, you make a payment. Based on a 3.22% interest rate, there is $48.30 in interest due. You will be required to pay the IRS $1,548.30 once you add this to your $1,500 tax obligation.
The underpayment interest accrues daily, so the longer you wait to make a payment, the more you will owe. Determining whether you owe the IRS money is crucial, and you should do it as quickly as you can. Besides all, rates for corporations differ from those for individuals and pass-through entities.
Underpayment Penalty may be Calculated using Form 2210
If you don’t meet the requirements for an exemption and you didn’t pay the whole amount of your tax liability throughout the year, you will also be responsible for an underpayment penalty. You must use IRS Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to determine the underpayment penalty. Checking out Form 2210 is a smart idea even if you are unclear of whether you will have to pay a penalty. This is because it provides a flow chart and instructions to assist you in determining whether a penalty is appropriate. If you are eligible for a waiver, you will also utilize Form 2210 to submit your request.
Deliver Payment to the IRS
You must send the IRS a payment once you have determined your penalty and completed Form 2210. You can do this by following the numerous ways, including:
- Using a digital wallet, credit card, or debit card when shopping online
- Money order/Check
- Immediate wire
- While e-filing, Electronic Money withdrawal
- Cash via a Retail Partner of the IRS
Tax payments must be made. Your tax liability will only increase if the proper amount of taxes is not paid or if a payment is made after the due date. Ascertain that you’re correctly estimating your taxes and paying by each due date. Don’t try to dodge an underpayment penalty if you end up receiving one. Pay as soon as you can, and if you are unable to do so, get in touch with the IRS to arrange a payment plan. We hope that by reading this article, you’re now prepared for tax season.
Frequently Asked Questions
Can you Pay All of Your Anticipated Tax at once?
Some taxpayers, including sole proprietors, partners, and shareholders of S corporations, are required to make quarterly tax payments if their total tax liability exceeds $1,000. They are referred to as expected tax payments. Estimated tax payments cannot be made fully at once. Each quarter, you have to pay them.
How can I Prevent being Penalized for Underpaying my Anticipated Taxes?
Making sure that you precisely calculate your estimated quarterly taxes is the greatest method to prevent paying fines for underpaying estimated tax. Make sure to always submit your payments to the IRS on time after you’ve estimated your amounts. In the event that you are unable to make the full payment, you can get in touch with the IRS to request a payment plan, which enables you to spread out the repayment of your debt while minimizing additional fees and interest.
What do the IRS “Safe Harbour” Guidelines Entail?
If you meet specific requirements, “Safe Harbour” rules allow you to avoid paying a penalty or to pay a less penalty. If you meet the IRS’s requirements, such as owing less than $1,000 or paying more than 90% of your tax obligation for the year, you can avoid an underpayment penalty.
How can I Minimize the Tax I owe the IRS?
4 Strategies to Reduce and Pay Your Tax Bill:
• Try to limit the harm first. Ensure that you truly owe the money.
• Ask for a payment schedule. You might be able to make installment payments to the IRS to pay your taxes.
• Borrow money from another source.
• Using an “Offer in Compromise”, Reduce Taxes.