underpayment penalty

Forum|Forum|10 months ago
May 28, 2025
4 replies
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I never had to pay the tax underpayment penalty in previous years, and now all of a sudden I do even though my income is more or less consistent? And it was quite a lot. Is this something new or recent? What is the rule for avoiding that? Yes, perhaps lately my interest from banks are higher as it increases every year but how am I supposed to withhold for bank CD earnings? Do I do a backup withholding or does that look bad? Do I just pay in advance estimated taxes to the IRS? I am afraid if I do the latter, I will lose that money that I paid and they won't consider that in my taxes for next year. And how would I go about doing that? Do I wait until my CD closes or do I pay the IRS as I get interest per month?

GCEA

To avoid an underpayment penalty, keep these key steps in mind:

Meet safe harbor rules – You’ll need to owe less than $1,000 when filing and pay at least 90% of your current year’s tax liability or 100% of last year’s tax liability to avoid penalties.
Stay on top of payments throughout the year – You can do this by increasing your paycheck withholdings or submitting quarterly estimated tax payments directly through the IRS’s Make a Payment portal .
Adjust your withholdings – If needed, update your W-4 and use the IRS Tax Withholding Estimator to help determine the right amount.
Request a waiver for penalties – If you’ve already incurred underpayment penalties, reach out to the IRS to request relief or file Form 843 (Claim for Refund and Request for Abatement) .

When estimating taxes, make sure to account for all income sources, including wages, interest income, capital gains, and more.

Best of luck!

km2438Author

I still don't quite get it. what about bank CDs? some months I get interest and some months I don't when it ends. can I do backup withholding option or is that a bad thing? ( what is backup withholding anyway? is that like setting aside money for taxes or you shouldn't do that for normal people?) do I pay quarterly for every month I receive CD interest or for in total of the end of year when the CD ends? and for w-4, what does 0-4 mean for maximum/minimum money deduction for taxes? how should you determine your number?

km2438Author

also, my sister owed underpayment penalty even though she owed the IRS less than $1,000 of taxes, so the rule didn't apply. why?

AmyATX

Underpayment penalties can really add up even if your income is fairly consistent.

TurboTax automatically calculates estimated tax payments based on your income and withholding when you prepare a return using a safe harbor of the "prior year". If you withholding was not enough to cover this minimum, you will see quarterly vouchers as part of your return (you will need to download a pdf copy of the return to see the vouchers themselves as they are not electronically filed with your return).

If you make these quarterly payments and have the same or higher withholding, then you will avoid the penalties.

Conversely, you can have your financial institution withhold funds from your investments which would then boost your overall withholding.

One thing to note, withholding from income items like bonuses, RSUs, etc, may not be substantial enough to cover those taxes. In that case, it's advisable to make a tax payment (estimated tax payment) on those amounts to avoid being hit with underpayment penalties.

The IRS also has a free tool that you can use to tweak your W-4 so that you reduce your risk of the under payment penalty: https://www.irs.gov/individuals/tax-withholding-estimator

baldietax

Few additional thoughts...

As to the question of your CD earnings being uneven etc, by default IRS assumes your income was earned evenly over the year, and any withholding is also applied evenly over the year even if you pay more withholding later in the year, withholding is always considered "timely". Estimated taxes however need to paid quarterly, it's one of the few things you enter into TT with a date, and the penalty calculation is then performed quarterly by dividing your 'safe harbor' tax amount due and withholding by 4, and lining that up with the estimated taxes per quarter.

Note - If you do have some larger unplanned income event later in the year that you couldn't plan ahead with quarterly estimated tax e.g. Roth conversion, then you can pay one-off estimated tax and then file using "Annualized Income" method on Form 2210 but that can be a lot of additional filing work. I wouldn't try applying that to uneven payments for CDs etc.

If you're able to increase withholding to make your 'safe harbor' amount described by others here (100% of your 2024 tax (110% if 2024 AGI > 150k) or 90% of your 2025 tax, whichever is smaller) then that is always considered "timely", tho you only have about 6 months left of the year to make up the difference thru withholding.

If you need to pay estimated tax but missed or underpaid for Q1 then you will have a penalty for that, but if you pay 50% of the total estimated tax for the year in Q2 (deadline 6/16) that will stop the penalty from accruing beyond a few months.

In TT under Other Tax Situations / Form W4 and Estimated Taxes you can provide 2025 estimates of your income to calculate the estimated tax. If you use desktop version go to Forms mode / Est Tax Options shows the calculation. There are probably other online calculators you can use. You don't need to use the vouchers generated by TT if you have better estimate.

You should not be concerned about paying estimated tax and those not being returned to you if you overpay. When you file 2025 you input these into TT and they are counted towards your final amount to be paid or refunded. IRS also tracks these payments and you can see them under your account on irs.gov.

Finally for payments don't use checks/vouchers just pay directly at irs.gov if able.

Opus 17

Employee

Also note, if this is the first time you have owed a penalty, you can file a request for an abatement.

https://www.irs.gov/payments/administrative-penalty-relief

You may also have be able to send the IRS a form 2210 (the penalty calculation form, using the annualized income method) to show the IRS they should remove or recalculate the penalty.