Whether you’re self-employed or a salaried employee, you’re responsible for paying taxes on your income. And the U.S. tax system is “pay as you go,” which means you owe taxes throughout the year — not just at tax time.
Salaried and hourly employees — that is, anyone who receives a W-2 — typically have taxes deducted from their paychecks, while self-employed people must send in estimated tax payments each quarter.
However, if a taxpayer somehow underpays their tax bill, they may not realize it until they file their tax return. At that point, it’s usually too late to avoid an IRS underpayment penalty, because the U.S. tax system requires individuals to pay their taxes throughout the year. Luckily, there are some strategies for avoiding this situation, if you’re proactive about it.
How to avoid the underpayment penalty
Here are some strategies to make sure you’re paying enough in taxes throughout the year, so you can avoid an underpayment penalty:
- If you’re an employee, use the IRS’s tax withholding estimator tool to determine how much you should have withheld from your paychecks. If you’re not having enough withheld, you can always submit a new W-4 to your employer with a higher dollar amount withheld so you cover your tax liability for the year.
- If you’re self-employed, use IRS Form 1040-ES to calculate your estimated tax payments.
- Taxpayers also can use one of two “safe harbors” to avoid underpayment penalties:
- One safe harbor is to pay 100 percent of your tax obligation from the previous year. That percentage jumps to 110 percent if your adjusted gross income was $150,000 or more ($75,000 or more if you filed using the married filing separately tax status).
- Another safe harbor is to pay 90 percent of the current year’s income tax obligation.
- Generally, you won’t get hit with an underpayment penalty if you owe less than $1,000 when you file your taxes.
Note that farmers and fishermen have special rules for tax payments.
It gets more complicated when you don’t receive a steady income throughout the year. If you get paid seasonally, or have high and low months, the IRS suggests annualizing your income by adding up how much you earn over one year, dividing it by twelve and paying tax based on the monthly average calculated. See this IRS page for more information.
How to calculate the underpayment penalty
Usually, if you owe an underpayment penalty, the IRS will calculate it for you and send you a bill. Also, some tax software programs will alert you, once you complete your tax return, if you owe an underpayment penalty.
However, if you want to do it yourself, you can use IRS Form 2210 to calculate the underpayment penalty.
An underpayment penalty is calculated based on:
- The underpayment amount.
- The time frame from when the underpayment was due.
- The IRS interest rate for the underpayment, starting on the due date taxes were owed. The current interest rate is 7 percent for this quarter (April through June 2025). It was 7 percent in the first quarter, too (January through March). However, interest rates are subject to change quarterly. The underpayment interest rate is the federal short-term rate plus three percentage points.
The IRS may waive the underpayment penalty for people in certain situations, including:
- Taxpayers who retired after age 62 within the past two years, or taxpayers who became disabled. In both situations, the reason for the tax underpayment must be “reasonable cause” and not willful neglect.
- Taxpayers who were unable to make tax payments because of an unforeseen circumstance, emergency, casualty or a natural disaster.
See the Form 2210 instructions for more information and other exceptions.
Example of an underpayment penalty
Let’s say you’re self-employed, and that, while filing your tax return, your accountant sees that you made the following payments:
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April 15: $2,000 (100 percent of the estimated tax due)
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June 15: $2,000 (100 percent of the estimated tax due)
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September 15: $2,000 (100 percent of the estimated tax due)
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January 15: $500 (estimated tax due was $2,000)
Your accountant determines that you underpaid your taxes by $1,500. Unfortunately, you’re above the IRS underpayment exemption threshold of $1,000, so you’re now subject to an underpayment penalty. In addition, you don’t have a reasonable excuse to request a waiver, such as disability, retirement or an unforeseen circumstance.
You could wait for the IRS to send you a letter, after you file your taxes, detailing the amount of the underpayment. However, the interest due started accruing on Jan. 15, the date the taxes were due. Waiting for a letter from the IRS adds to the interest you’ll owe.
If the underpayment amount is nominal, waiting for the IRS letter may be the most foolproof way to meet your tax obligation.
But if your underpayment is substantial, the penalty could be significant. In that case, it might be wise to run the numbers with your tax professional to pay the tax and penalty sooner — minimizing the amount of time the underpayment is allowed to rack up those fines.
If you do find yourself in a situation where you owe a tax bill, it’s generally best to go ahead and file your tax return — even if you can’t pay right away. That’s because the IRS’s failure-to-file penalty is 5 percent of what you owe, per month, up to 25 percent.
But the failure-to-pay penalty is much lower: 0.5 percent per month, up to 25 percent.
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