What Happens if You Underpay Your Taxes?

For most workers, Form W-4 (filed with your employer) allows you to claim exemptions and accurately estimate your income tax liability pay period. But sometimes, changes during the year such as marriage, divorce, or a raise can throw off those estimates. If you’re pushed into a higher tax bracket, you face the risk of accidentally underpaying your income taxes for the year.

Once you file your return in the spring, you will find out exactly how much you owe. In most cases this amount is relatively close to the amount you paid during the year. If you’ve overpaid, you receive a refund, but if you’ve underpaid, you will owe the IRS an additional amount.

Now here’s the tricky part: A small tax underpayment is no big deal, but you can run into problems if you’ve underpaid at 90 percent or less than your actual tax debt. In addition to charging you the balance of taxes due, the IRS will also tack on a penalty of 3.398 percent of the underpaid amount.

So, how can you avoid accidentally triggering a tax underpayment fee? The key is to review and correct your W-4 in the event that any of these situations occur:

• You get married or divorced
• You add a child to the family
• You or your spouse loses a job
• You or your spouse takes a new job, or a second job
• You purchase a home

In some cases, the above situations might actually decrease your tax liability. Reviewing your W-4 in those circumstances could help you keep more of your paycheck each week.

Finally, the IRS does wave the underpayment penalty if you became disabled or retired during the tax year. Discuss these issues with your tax professional to be sure you don’t pay unnecessary fees.