What to Know If You Underpaid your taxes

In this article: The underpayment penalty is a tax penalty charged to tax payers who didn’t pay enough tax during the year also referred to as underpayment of estimated tax.

Published Abr. 16, 2018

Reading Time: 2 minutes.

What’s worse than doing your taxes? Realizing that you need to pay more than you thought! More than 1 out of 3 Americans receive a tax refund. However, and especially if you’re a high-earner, some taxpayers get the nasty surprise of a tax bill instead of a check in the mail.  In some cases, this bill can be thousands of dollars. To top it all off, you have to pay an underpayment penalty to the IRS if you owe more than $1,000, if you paid less than 90% of the tax for the current year, or if you paid less than 100% of the tax shown on the return for the prior year.

Causes for an Underpayment Penalty

What are the usual suspects when it comes to getting a bill rather than a refund check? The two main culprits are one-time events and increasing income.

One-time Event

A unique windfall event like a large capital gain from a property sale can be a trigger. A common instance here is when you sell your real estate property during that year. A newer instance is the sale of cryptocurrencies, which the IRS has constituted as property. If you sold any cryptocurrencies late last year there is a good chance you have significant gains from the sale that can amount to a bigger tax bill than expected.

Increased Income

Going from a single-income to dual-income family, or when one partner gets a large raise or bonus, can both drive a larger tax bill. If your income increased but you didn’t take additional deductions you can find yourself underpaying your taxes and get hit with the penalties.

 

How Much is the IRS Underpayment Penalty?

The amount you’ll be fined is based on how much you owe and how long you’ve owed it for. The typical penalty is 0.5 % of the total amount you owe calculated for each month you haven’t paid for it. If you are hit with a penalty you may also be required to pay interest on the amount you owe. 

How to Avoid for Underpaid Taxed?

If you received an income increase this year or expect a big bonus by year-end, make sure to file a new W-4 form with your employer to withhold more taxes with fewer allowances

Underpaid taxes are usually driven by a positive occurrence – increased income. If you underpaid taxes it also means unnecessary penalties and an outflow of cash you often did not expect. Estimating your tax bill ahead of next year’s tax season or talking with a financial planner will help you avoid penalties and budget better.

Disclosure: This blog is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accounting, tax, legal or financial advisors. The observations of industry trends should not be read as recommendations for stocks or sectors.

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