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How Much is the IRS Tax Underpayment Penalty

Tax Underpayment Penalty Rate

If you fail to pay your federal income tax bill in full by April 15, the tax underpayment penalty will increase the amount you owe to the IRS. And to make matters worse, your tax debt will continue to increase each month until you pay it off.

There is a wide range of reasons why you may underpay your federal income, but you can be sure that the IRS has a penalty to apply for each one. The standard underpayment penalty is equal to one-half percent of the income tax you fail to pay and accrues on a monthly basis. The maximum cumulative penalty the IRS can charge you is 25 percent, so at a rate of 6 percent per year, it will continue to increase your tax debt for a little over four years. However, the IRS will also increase the amount of your tax debt with monthly interest charges that accrue concurrently with the penalty.

The 20-Percent Accuracy-Related Penalty

The IRS can increase your tax debt immediately by 20 percent when your income tax underpayment is the result of reporting inaccurate information on your tax return and it’s attributable to your negligence or disregard of the tax laws. In the absence of negligence or disregard, the penalty automatically applies if you substantially understate your tax liability for any reason. For example, if you omit $20,000 of self-employment income from your tax return because you mistakenly believe that it’s not taxable, the IRS can claim that your negligence in failing to read the instructions to your return warrants imposition of the penalty. However, even if the agency can’t show that you were negligent, it can still impose the penalty if the resulting tax underpayment is substantial, meaning that the amount of income tax you owe on the $20,000 is at least equal to the greater of $5,000 or 10 percent of the correct amount of tax you should have reported on the return.

Substantial Understatement: Greater of $5,000 or 10 Percent

To illustrate how the substantial understatement works, assume you report a tax bill on your return of $3,000 without including the $20,000. If inclusion of the $20,000 increases your tax bill by $4,500 to $7,500, it represents 60 percent of the correct amount of tax you should be reporting (4,500 / 7,500). However, since the increase is less than $5,000, you escape paying the accuracy-related penalty.

Reference: Internal Revenue Code § 6662 (Accuracy Related Penalties)