Why do I have an underpayment penalty when my federal tax due is under $1000?

[Gautas]

IRS guidance seems to suggest that an underpayment penalty doesn't apply if amount due is under $1000, see for example https://www.irs.gov/taxtopics/tc306

[RobertG · Accepted solution]

Underpayment penalties are assessed if you don't withhold or pay enough tax on income received during each quarter.

In fact, it's entirely possible to get hit with an underpayment penalty even though you paid your tax bill in full by the April deadline or are getting a refund.

Example: Joe is self-employed and estimated next year's tax bill at $20,000. Rather than making 4 quarterly payments of $5,000 apiece, he chose to pay $500 in each of the first 3 quarters, and the remaining $18,500 in the fourth quarter.

When he filed, his actual tax bill came to $17,270 and he got a $2,730 refund. However, he got hit with the underpayment penalty because he underpaid his estimated tax in the first 3 quarters.

Tip: To reduce or possibly even eliminate your underpayment penalty,  search for annualizing your tax (use this exact phrase) inside TurboTax.

This will take you to the underpayment penalty section and we'll take you through the steps to possibly reduce your underpayment penalty.

(If you don’t see Jump to annualizing your tax in the search results, make sure you’re in your return and not on the Tax Home page.)

[Opus 17]

I believe that in the program the penalty calculation is option, you can skip it and wait and see if the IRS bills you.  And in that case, if this is the first time you owed a penalty, you can request a waiver. 

https://www.irs.gov/businesses/small-businesses-self-employed/penalty-relief-due-to-first-time-penal...

But as the expert said, you can sometimes owe a penalty if you are under-paid in a quarter even if you catch up later.  This can happen if you have a large lump sum income such as selling an investment. 

[VolvoGirl]

I had a refund once and still had a penalty for not paying in evenly during the year.  I think you can only skip it in the Desktop program.  Don't know a way to leave it off of the Online version.

You might be able to eliminate it or at least reduce it.  You can go to Federal Taxes tab or Personal tab, under Other Tax Situations and select Start by the Underpayment Penalties. You will answer a series of questions that may reduce or eliminate the penalty. Or you can elect to have the IRS figure the penalty for you.  It's form 2210.

It's under

Federal or Personal (for Home & Business Desktop)

Other Tax Situations

Additional Tax Payments

Underpayment Penalties - Click the Start or update button

If you have the desktop program you can switch to Forms Mode (click forms in the upper right (left for Mac)) and open the 2210 form.

[Gautas]

Thanks all for answers!

[Carl]

The underpayment penalty can also occur if you didn't pay in one quarter, even if you doubled up and "covered it" with the next quarterly payment. Then it's really more of a quarterly late payment penalty, than it is an underpayment penalty.

It's also possible if your quarterly income varies throughout the year. For example, you have $20K in the first quarter, only $2K in the second quarter (because your business is seasonal) and $20K in each the third and forth quarter. That's a total of $62K for the tax year. So your quarterly payments for each quarter would be (as an example) $4000 for each the first, third and forth quarters, and only $400 for the 2nd quarter. The total taxes paid each quarter add up to $12,400 which "averages out" to $3,100 per quarter. Having only paid $400 the 2nd quarter is a gross underpayment.

By default, the IRS averages things out and by that average you underpaid the forth quarter - even though your total taxes paid may equal or exceed your total tax liability at year's end. Here's how to account for that and reduce, if not completely eliminate the underpayment penalty.

In the TurboTax under the "Other Tax SItuations" tab elect to start/update "Underpayment Penalties" and work it through. It can't hurt. But it could help.