Underpayment Penalties and Estimated Taxes
Hello Community,
Occasionally in tax support, we see a trend in the types of questions we get. This year we are seeing more questions about the Underpayment Pentalty than normal. The IRS has said they are seeing an increase in taxpayers who are subject to the Underpayment Penalty. So, it isn't a surprise we are seeing more questions on this topic in Support.
The IRS has many resources to educate taxpayers about how to pay estimated taxes in order to avoid paying the Underpayment Penalty. Keep in mind that even your payroll tax for Federal Withholdings is an estimated tax. We all should "pay as we go" in order to pay an estimated tax and avoid paying penalties.
Keep in mind there are 3 requirements the IRS has for paying estimated taxes. This is the smaller of:
- You owe less than $1,000 in tax after subtracting withholdings and credits, or
- You paid at least 90% of the tax for the current year, or
- You paid 100% of the tax shown on the return for the prior year (special rule applies to higher income taxpayers).
What can you do if you get in a situation where you may owe the penalty? Our software supports the Form 2210 and you can request a waiver, or have us calculate the penalty. Paying sooner will help you avoid interest as well.
For more information, see this article in our community.
Comments
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The bulk of my income is from Cd's at savings banks and SS as I am retired. Can I request mandatory with holding from my banks?
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Hello Sinn,
I suggest you check with your bank. It isn't common for a 1099-INT to have federal withholdings, but there is a box for that. You can also request the Social Security Admin to withhold federal taxes.
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Hello Community,
Just want to know if the platform can detect underpayment amount and both federal and state levels so we can pay the underpayment portion through FreeTax USA.
Thanks
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The platform can't help you detect underpayments on an ongoing basis. It only calculates the net result of taxes owed for the calendar tax year. When an underpayment penalty is applicable, the software will make the calculation and add to the amount due.
The IRS has resources to help you determine if you need to make Estimated Tax Payments through the year:
On way to make a payment directly to the IRS when you know that you need to make an Estimated Tax Payment, you can do so directly on the IRS.GOV website.
To make STATE Estimated Tax Payments, performing an internet search for "tax payments for XXXX" with XXXX being the name of your state.
If you want to make the software prepare payment vouchers for you for the current year (2024), you can set those up. Menu: Misc > Payments > 2024 Estimated Tax Payments
You can also make the software prepare State payment vouchers for the current year (2024) from the State menu > 2024 Estimated Tax Payments.
Note: The federal and each state Estimated Tax Payment Voucher is set up individually.
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I think I have found a bug or scenario where the platform does NOT detect/calculate an underpayment penalty when it should.
Scenario: If you have inconsistent W2 income and/or investment income and pay varying amounts via estimated taxes to IRS, and are due a refund at the end of the year… You still may have a tax penalty especially if you paid a disproportionately higher estimated payment in Q4. Q4 is when many receive the majority of their dividends (1099-DIV). And when many calculate how much they might do for a Roth conversion (1099-R).
However FreeTaxUSA (FTUSA) does not consistently catch scenarios like the one above and identify the underpayment penalty (which is potentially applicable even if you are due a refund for overpayment).
If you simply 'know' you should receive an underpayment penalty but FTUSA doesn't catch it - I've found a work-around to induce FTUSA to properly catch the penalty: Go to Misc > Underpayment and answer the question: "Yes | No - Do you want to answer questions that may reduce or eliminate your underpayment penalty?"
Once you do that, FTUSA should THEN correctly identify and calculate the penalty. (and if you enter annualized income data on F2210 you may be able to eliminate/reduce the penalty). But if you don't do the above, you may very well complete what appears to be a perfectly correct return, file it and later receive a 'surprise' penalty bill from the IRS for underpayment - Ouch! 😣
I've created a more detailed write-up on the bug here: FreeTaxUSA Platform *NOT* Detecting Underpayment Penalty In All Conditions - is this a Bug?
But there is a work-around and I suspect this is very easy to fix. 😁
Hope that helps!
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Hi Trhao,
Thank you for bringing this to our attention. You are correct that it is possible, although rare, to be hit with an underpayment penalty even when you have a refund. As the IRS says, taxes are a "pay as you go system". Our software is set up to allow the taxpayer to explore various scenarios for any underpayment penalty or request a waiver of the underpayment penalty. There are pros and cons to doing it automatically or manually.
I am not sure it is an easy fix or a bug, however, I am going to send a request to our development team.
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I paid my quarterly taxes in Sept. 2023 and Jan 2024. However, your tax program is hitting me with an underpayment penalty, because it thinks that I should have paid in April and June, 2023. However, the IRS and the State of California extended the tax filing deadline for Californians impacted by December and January winter storms to October 16, 2023.
You might want to look into that.
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Hi TomT, thanks for your comment.
You're correct that affected taxpayers were granted the additional time to pay estimated tax payments on or before October 16th due to the storms, floods, and mudslides in California.
I will bring your comment to the attention of our software team.
Additionally, and to your point about being charged a penalty, the IRS announced if a taxpayer receives a letter for a late filing or penalty for the affected time period, the IRS is providing a number on the notice to call and have the penalty removed. The IRS also announced it would automatically identify taxpayers located in the covered areas and apply filing and payment relief.
Assuming you're in the affected area and have a balance due, you may choose not to include the underpayment penalty as part of paying your balance due.
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"The platform can't help you detect underpayments on an ongoing basis. It only calculates the net result of taxes owed for the calendar tax year. When an underpayment penalty is applicable, the software will make the calculation and add to the amount due."
This is not quite tree. I encountered a bug in a specific scenario whereby FreeTaxUSA doesn't catch the penalty or calculate it: In the case where you A) had W2 earnings in Q1 (only - say you retired then) and B) investment earnings with associated estimated tax payments weighted 90% to Q4…. and slightly overpaid and are due back a small refund… There should still also be penalty. FreeTaxUSA does NOT catch this as an underpayment penalty. FreeTAxUSA does not steer the user towards Misc > Underpayment. It completely misses the penalty in this scenario! This appears to be a consistently reproducible bug.
If you 'know better' and manually navigate to the F2210 underpayment screen and answer the Yes/No question - only THEN will FreeTaxUSA identify and catch the penalty.
Couple fixes:
Catch the penalty in the above scenario, make the the user sees it and include it on 1040. Even if there's a refund, there can still be an underpayment penalty as in the scenario above and FreeTaxUSA needs to catch that scenario.
Steer the user towards the F2210 underpayment dialog if there's a penalty.
If the F2210 question is un-answered at the end when doing quality checks - indicate to user as a warning at the least.
I posted elsewhere a more detailed write-up of the bug I found - that post is awaiting approval. Great software. Hope the info above helps!
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Well, I'm an old coot (76 years old). I have never paid an estimated tax. Every year I have a sizeable income. I always owe a lot. The "penalty" is trivial. It is just the amount of interest you owe on the late tax payment.
Example, for 2022 I owed taxes of $42,211. The "penalty" was $1,466 as computed by the IRS. Trivial!. All my assets are in the stock market except for my home value. By not paying estimated taxes and leaving the funds in the market, the gains far exceed the "penalty". Every year, year after year.
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If you are thinking about underpayment penalties and estimated taxes, remember the IRS has specific rules to avoid these penalties, owing less than $1,000 after withholdings, paying at least 90% of the current year’s tax, or paying 100% of the prior year's tax. If you are facing penalties, FreeTaxUSA supports Form 2210 for waiver requests and penalty calculations. For more details, check the IRS resources or the FreeTaxUSA community article.
Hope it helps!
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Why not just take $1500 out of the market and make an estimated tax payment? I sure your gains on $1500 "in the market" do not exceed the $1466 penalty
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I don't see how that helps. I would owe $40711 (=42211-1500) in taxes and the penalty would be a little less then the $1466 amount.
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Hi Petec,
When the IRS assesses a penalty, they may start assessing interest on any unpaid balance. That is the flipside. I see what you mean by your income left in the investment will continue to grow until taxes are due April 15. I suppose the best option for you may be to allow the underpayment penalty if you earn more on those taxes held in an investment until that time.
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(Need to take $42,211 out of the market to avoid the penalty of $1,466.)
For 2022, the interest rates for penalty calculation was 3%(Q1), 4%(Q2), 5%(Q5), and 6%(Q4).
S&P 500 went down 18% in 2022.
For Q1 2025, the interest rate for penalty is 8%, and S&P 500 is down in Q1
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In some years I faced the underpayment penalty. However I was able to remove the penalty by using the annualized income method (Form 1220 Part I, check box C only). Just play with Box C and Box D, find out which combination works better. In some years it led to total elimination of the penalty, in other years, reduction.
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Hello,
The Menu Path:
Misc > Payments > Underpayment Penalty (Form 2210)
Does not seem to work for 2024 taxes, as the option for Underpayment Penalty (Form 2210) is not in the Payments section and I could not find it anywhere.
Even if we have a refund, we could incur a penalty if estimated payments were not done timely, especially if income fluctuates during the year. We need to be able to access Form 2210, and especially schedule AI, in order to determine if we can eliminate or reduce a penalty that the IRS (and equivalent for the state-specific 2210) will calculate even if FTUSA assumes there isn't one because we got a refund.
How can we access Form 2210 in the 2024 tax year version?
Thanks.
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The Menu Path:
Misc > Payments > Underpayment Penalty (Form 2210)
Does not seem to work for 2024 taxes, as the option for Underpayment Penalty (Form 2210) is not in the Payments section and I could not find it anywhere. How do we access it in the 2024 tax year version of FTUSA?
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It looks like it will only show up as an option if the system thinks you've underpaid. Maybe check what you've put in income? I think FreeTaxUSA isn't showing you the option. If you don't owe at least $1k, that option doesn't show up because you don't need to worry about it.
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Thanks, but you can actually still owe a penalty if you owe less than $1000, meet the safe harbor, or even if you get a refund, if your payments are not through withholding or paid through estimated payments timely when the income was realized. For example, if you are a seasonal worker and you made $100K for the year, but $90K of that was made in December, and you paid the full tax (say it's $12K) in the 4th estimated payment on January 15, you will owe a penalty even if you paid the full tax that year, because the IRS assumes that you made the $100K throughout the year and expected you to pay $3K each quarter. To eliminate the penalty you need to use Form 2210, schedule AI, to show that 90% of your pay was realized in December so that the 4th estimated payment is considered timely. FreeTaxUSA would not be able to identify this because they don't know that 90% of your pay was done in December, so you need to access the Form 2210 to show when in the year the different proportions of your pay were realized.
This is similar to the scenario that trhao identified in his/her post of March 2024 above in this tread and proposed navigating directly to the form in misc>payments>underpayment penalty, but it does not seem to be there.
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