What to Know About Penalties for Estimated Tax Underpayment

As a self-employed professional or freelancer, the faster you file your taxes, the sooner you can focus on your business. But watch out for penalties for underpaying on estimated taxes. The risk of underpayment is higher for freelancers whose income varies from week to week and month to month.

With income flowing in from multiple clients and gigs, it’s crucial to understand what can happen if you don't accurately calculate and pay quarterly estimated taxes. If you miss a payment, for example, the IRS might send you a notice that you are required to pay a penalty for underpayment.

What leads to underpayment of estimated tax penalties?

The IRS fines taxpayers who pay less than 100% of the estimated tax based on the previous year or less than 90% of the current year's amount.

The total tax to pay is the combination of your estimated tax and the amount already withheld. Find this confusing? You're not alone.

As a freelancer, you're responsible for estimating the tax you owe, and you might end up accidentally paying less than the total estimated tax.

Once you receive a notification that you have underpaid the estimated tax, you must immediately pay it to avoid further penalties and interest charges. To calculate the underpayment penalty, the IRS has Form 2210 in place.

Underpayment of estimated tax penalties: how are they calculated?

Form 2210 helps you find the exact penalty, which isn’t a fixed percentage or amount. Your penalty amount depends on:

1. The total amount underpaid
2. The amount of time that has passed
3. The interest accrued on the underpaid amount

For instance, if your estimated tax was $2,000, and you only paid $1,800, you must pay this difference as well as the corresponding penalty. Form 2210 will help you find the amount you owe and the penalty.

Failure-to-pay penalty

Underpayments receive a failure-to-pay penalty of 0.5% for each month or part of the month until payment is made. So, an underpayment for three consecutive months means that you add the remaining amount plus a 0.5% penalty for each month. In addition, you will have interest charges.

Interest on underpayments

Next up, you need to pay interest on your underpayments, similar to the interest earned on your overpayments to the IRS. The IRS releases new interest rates each quarter based on the federal short-term interest rate.

Are there any exceptions to the underpayment penalty?

You’ll be glad to know that some underpayment of estimated tax does not result in a penalty. Here’s a quick list of those cases:

1. You are a retired taxpayer and are above the age of 62.
2. Your total tax liability is below $1,000.
3. You paid 100% of the previous year’s taxes and paid at least 90% of the current year’s amount.
4. You missed a payment because of a casualty, natural disaster or unusual circumstance.
5. You had reasonable cause to underpay the taxes and have not willfully ignored the payment.
6. You were disabled in the previous tax year or are disabled in the current one.
   

If these do not apply to you, you have the option to dispute the penalties. For example, you can do so if the IRS gave you a piece of incorrect written advice that led to the penalty.

How can FlyFin help you avoid penalties?

FlyFin's A.I. finds every possible tax deduction in your business expenses. In just 5 minutes, the A.I.-powered tax penalty calculator generates your quarterly estimated taxes for you, based on your income and deductions. Automatic notifications never let you miss a tax filing deadline or pay unnecessary penalties.

FlyFin's tax CPA team is here for you 24/7 to answer any questions. When annual income taxes are due, a FlyFin CPA will be standing by, ready to file a 100% accurate tax return for you.