Tax Underpayment Penalty

In the following paragraphs, a comprehensive explanation on the penalty for tax underpayment has been provided here. The penalty rates are prescribed by the IRS on an annual basis and are often subject of changes, which are usually notified in January. To know more about some general rules and rates that affect your income tax payment, read on.
In the United States, State and Federal bodies, and chiefly the Internal Revenue Services (IRS) rely on your usual tax withholding to collect taxes. Another way of payment of taxes such as income tax is through the payment of estimated taxes. This mechanism eliminates the possibility of underpayment of taxes and also ensures that most of your taxes get paid on time. Underpayment of taxes is chiefly the payment of taxes, lesser than the total tax liability which is actually owed.

Upfront, the current tax underpayment penalty rate is 4% for the number of days the tax goes unpaid from (through) April 16, 2010 to April 15, 2011. So basically you will be paying off the pending amount as well as the penalty in the subsequent future when you file your 2010-11 return or post April 15, 2010.

General Rule
For the underpayment of taxes, the IRS has established some General Rules in the Publication 505, most of which applies for 2010-11 year's filing and underpayment penalty payment. In accordance with the general rules of penalty, you would owe a penalty for 2010 financial year if, the total tax that you paid through withholding or timely estimated tax payments, is not equal to (the least of):
  • 90% of the total tax for 2010, or
  • 100% of total tax for 2009
Thus, if your current tax paid through the withholding and estimated payments, does not exceed the aforementioned percentages, then you may owe a penalty on the top of tax amount. However, if the total tax paid exceeds the percentages, then you do not owe a penalty. However, bear in mind that, late or unpaid quarterly payment for employed people who withhold, is also penalized. It means that if you owe a tax which exceeds the aforementioned for mentioned conditions, then you would be subject to the penalty, which is filed in the following forms:
  • 2210 Underpayment of Estimated Tax by Individuals, Estates, and Trusts
  • 2210-F Underpayment of Estimated Tax by Farmers and Fishermen
Penalty for Farmers and Fishermen
In certain cases the IRS makes relaxations in the general rule and the applicability of the general rule. For the financial years 2009 and 2010, if an individual's income, (not less than two-thirds of the Gross Income), is obtained from farming or fishing, then in aforementioned rule, the 90% is substituted with 66.66%.

Penalty for Higher Income Taxpayers
If an individual's Adjusted Gross Income (AGI) shows the characteristics as follows:
  • If an individual's AGI exceeds $150,000 as of 2009 filing, or
  • And exceeded $75,000, for married people filing a separate return, forth 2010 financial year
In such cases, the 100% in the aforementioned rule is to be substituted with 110%.

Periodic Payment Rule
The withholding of the tax and payment of estimated tax is done in 4 different parts, with one part spanning over a quarter of 3 months. Hence, if at the end of the financial year through April 15, 2011, if you owe a tax for any quarter which is lesser of the following then a penalty would be changed.
  • 22.5% for 2010, or
  • 25% for 2009
For higher income tax payers (conditions stated above), the 25% is considered as 27.5%.

Please note that these rules are applicable as of date and for the financial year 2010 and are subject to changes by the IRS by notification. Hence when you file your income tax return and are being levied with a penalty, you will have to take into note the current laws. Also there are several rules regarding the previous year's pending balances as an unpaid tax. Balance and penalty which goes unpaid is subject to some further implications.
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