As U.S. taxpayers, we are required to pay a certain amount to the IRS during the course of the tax year. Failing to do so can lead to significant underpayment penalties. While these penalties can hit anyone at any time, there are certain situations where underpayment penalties are especially common. For example, if you have a substantial increase in your income due to cashing in an investment, you may have increased your income without increasing your withholding or making estimated tax payments. Similarly, if you retire and your payroll income is replaced by a pension and Social Security income, you may not have adequate withholdings in place and thus may face an underpayment penalty.
Two Safe Harbor Methods to Avoid an IRS Underpayment Penalty
In order to avoid an unexpected and unpleasant surprise at tax time, it is important to pay at least a minimum safe harbor amount during the course of the year. The following are two safe harbor methods you can utilize to avoid an underpayment penalty:
- Choose a safe harbor amount that is calculated based on the tax you owe for the current year. As long as your payments to the IRS are equal to or exceed 90% of your current year's tax liability, you will meet the safe harbor amount and avoid an underpayment penalty.
- Choose a safe harbor amount that is calculated based on the taxes you owed in the immediately-preceding tax year. As long as your current year's tax payments are equal to or exceed 100% of the amount of the prior year's tax, you will meet the safe harbor amount and avoid an underpayment penalty.
If you are already facing an underpayment penalty or other problem with the IRS, it is not too late to seek assistance. Your first step should be to educate yourself about tax problems and the process for finding solutions. To get started learning more, we encourage you to check out our free guide, The Ultimate Guide for IRS Problems.