Why you were charged an underpayment penalty, and what to check

Why this penalty surprises people

Imagine a consultant who has a strong December, files in the spring and pays the entire balance with her return. She then receives a notice with a penalty added. She was not late filing and she was not late paying, so the charge looks like a mistake. It is not necessarily one.

The U.S. system is pay-as-you-go. Tax is expected to be paid during the year, through withholding or estimated payments. The IRS says a penalty may apply if you underpay during the year, even if you pay the whole balance when you file. That is a separate idea from late filing and late payment.

How the IRS decides whether you owe it

Form 2210 is the form used to determine whether you owe the penalty and how much.

The IRS describes safe-harbor tests that can avoid the penalty. In general, you avoid it if what you still owe at filing is small after withholding and refundable credits, or if your payments reached a set share of either this year's tax or last year's tax, whichever is smaller. The exact dollar and rate thresholds are time-sensitive and differ for some taxpayers, so check the current Form 2210 instructions for your tax year. The IRS notes special rules for farmers and fishers, certain household employers and higher-income taxpayers. Estimated payments are generally made in four equal amounts.

When income arrives unevenly

Some people earn most of their income in one season, such as a seasonal contractor or someone who sold a property late in the year. For these situations, the IRS says the annualized installment method may help. It matches your required payments to when you actually earned the income. This method is reported on Form 2210, so it is worth looking at before you accept a penalty amount, especially if your income was lopsided.

Asking for a waiver

Waivers are limited. The Form 2210 instructions say the IRS may waive all or part of the penalty in two situations. One is that you retired after age 62 or became disabled in the relevant year or the year before, and the underpayment was due to reasonable cause and not willful neglect. The other is that the underpayment was due to a casualty, disaster or other unusual circumstance and it would be inequitable to impose the penalty.

To ask, check the waiver box in Part II of Form 2210, attach the form and a statement that explains why the requirements were not met and the period involved, and include supporting documents, such as retirement or disability dates or police or insurance reports. For federally declared disasters, the IRS says you generally do not file Form 2210, because relief is applied automatically, with an exception for the annualized method.

One point trips people up. The IRS reasonable cause page says that general reasonable cause relief does not apply to the estimated tax penalty. Use the specific waiver rules above instead.

Reading a notice that includes this penalty

Look at how the notice calculated it. If you believe the amount is wrong, because a payment was missed, a safe harbor applies or the annualized method would give a lower figure, say so in writing, show your numbers and attach proof of payments. If you agree with the notice, follow its payment instructions. Interest and other penalties may continue on unpaid amounts, so check the notice for the date.

Planning ahead, and where a letter fits

For next year, the practical fix is to adjust withholding or estimated payments so the pay-as-you-go test is met, ideally with the help of a tax professional who knows your income. If you need to explain a disagreement or support a waiver, IRS Audit Defense Pro is software that helps you organize your facts and draft a letter you review and send yourself. It does not give tax advice, it is not a CPA or enrolled agent, and it cannot predict whether the IRS will waive anything.

Frequently asked questions

Sources

• IRS Tax Topic 306: Penalty for underpayment of estimated tax
• IRS: Instructions for Form 2210
• IRS: Penalty relief for reasonable cause

Related guides

• How to request penalty abatement from the IRSStart by checking whether your penalty qualifies for administrative relief based on a clean compliance history.
• Reasonable cause statement sample: telling the story of what happenedA reasonable cause statement explains, in dated order, what prevented you from meeting a requirement, how you tried to act with ordinary care and prudence, and what you did once the problem ended.
• Penalty abatement request letter sample (first-time relief)A penalty abatement letter names the penalty and tax period, describes your filing and payment history, asks the IRS to consider administrative relief and, if needed, reasonable cause, and lists what you enclose.
• What a CP14 notice means and what to do nextA CP14 is the IRS balance-due notice.
• What to do when you owe the IRS and can't pay it allIf you owe the IRS and cannot pay in full, file on time anyway, pay what you can, and contact the IRS about a payment plan, a pause in collection if you cannot cover basic living costs, or in some cases an offer in compromise.