The Not-So-Hidden Consequences of Underpayment

It’s that time of year where employers begin sending out W2s and millions start gathering up important tax information to be filed. Some will get big returns, while others will be notified that they owe money.

While many Americans pay off the taxes owed at the time of their filing, what they fail to realize is that they are already being penalized for failure to pay taxes throughout the year.

What are Underpayment Penalties?

For most working individuals, taxes are paid on a steady basis through income tax withholdings. When tax season comes around, they can either expect to break even, get money back, or owe an amount.

Independent contractors, freelancers, and those getting paid “under the table” will have to make payments to fulfill their tax obligation. If these taxes are not accounted for throughout the year, then you will be penalized.

In most cases, the penalty is calculated by taking .5% of taxes owed and multiplying it by every month that they were not paid. It doesn’t seem like much at first but if you owe $2,000 and haven’t paid for 6 months, that’s around $60 extra tacked on to your owed amount.

How You Can Avoid Penalties

The most efficient way to avoid underpaying taxes is to make an effort to pay them quarterly. You can calculate your taxes with Form 1040-ES and pay what you owe at that time. That way, in the event that you do owe money, it will be substantially less than if you attempted to pay all at once. That being said, all owed taxes from the previous year should be paid by January 15.

Individuals who increase their income throughout the year may also not realize that their tax withholdings are not enough to match the growth. This puts many tax payers in a bad spot since they may be unaware of their owed amounts until they finally file their taxes. The moment your income situation changes, you should figure out what that means for your tax situation.

You should also keep a calendar that lays out the estimated federal due dates. For instance, filing your income taxes before January 31 and paying any owed taxes will keep away those pesky penalties.

The Good News

With all the rules and consequences surrounding taxes, it’s easy to get discouraged and worried about the future. Not everyone will be subject to the same penalties, or even incur them.

There are instances where you can avoid the penalties and fees incurred by underpayment.

  • Unpaid taxes are less than $1,000
  • No taxes were owed the year prior
  • 90% of owed taxes have been paid
  • Natural disasters affecting payments

Recently, the IRS has made some changes in accordance with last year’s Tax Cuts and Jobs Act. What this means is that now a taxpayer can avoid penalties if they paid at least 85% of owed taxes from the previous year as opposed to 90%.

While this is a huge sign of relief for those who didn’t meet existing withholding standards, a large part of the country will still be penalized.

The best thing to do in order to avoid any penalties and fees come tax season is to start taking stock of what you owe from last year, which can be done with assistance from the withholding tables that are provided for reference.

Ignoring your taxes, specifically what you owe, will only come back to bite you. When it comes to estimating, paying, and filing taxes the sooner you get it done, the less headaches you’ll have in the future.