If you've underpaid taxes to the IRS (typically because of too little withholding from your paycheck or not making enough quarterly estimated tax payments), then you're required to pay the difference of what is owed plus an underpayment penalty. You'll know if you owe this penalty because the IRS will send you an official notice. 

How is the IRS Underpayment Penalty Calculated?

The underpayment penalty is not one set percentage. It will be based on the following criteria:

  • Your total underpayment amount
  • The quarter that you underpaid
  • The interest rate for underpayments, which is updated by the IRS each quarter

To calculate your penalty, use Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, and a worksheet from Form 2210 Instructions.

You can also have the IRS calculate your underpayment penalty and send you the bill.

How to Avoid the Underpayment Penalty

To avoid the underpayment penalty in the future, you could let your employer that you’d like to have a larger amount of taxes withheld from your paycheck using a W-4.

If you have self-employment income, the IRS recognizes that it may be difficult to accurately predict how much estimated tax should be paid since earnings can vary throughout the year. Therefore, they offer the following “safe harbor” method for calculating your estimated payments and avoiding the underpayment penalty:

  • Target owing less than $1,000 on this year’s tax return
  • Demonstrate that you paid at least 90 percent of the tax shown on the return for the taxable year or 100 percent of the tax shown on the return for the prior year, whichever amount is less.

Also note that in some circumstances the penalty can be disputed, reduced, or removed. However, you must meet specific criteria for this to be considered. Please see the IRS webpage Underpayment of Estimated Tax by Individuals Penalty for more information.