IRS Income Tax Underpayment Penalty

If you're an employee and underpay your annual income taxes by less than $1,000, you will not have to pay a penalty. If the amount of the underpayment exceeds $1,000, you will have to pay one. As of 2012, the underpayment penalty is 0.5 percent of the total amount unpaid for each month it is left unpaid and can rise as high as 25 percent of the total tax liability.

If you're self-employed or a freelancer and have an annual tax liability of $2,000 or higher, you must file quarterly estimated tax statements and make payments along with these estimates. The penalty for underpayment is 0.5 percent of the amount due for each month it is not paid. For quarterly tax filers, these amounts can add up quickly because of the frequency with which quarterly taxes are due. The fees are capped at 25 percent of total tax liability.

If your underpayment is due to fraud or negligence rather than miscalculation or a misunderstanding of the tax code, the IRS can charge you a penalty of up to 20 percent of the amount you owe. Examples of fraud include deliberately hiding or misreporting income, or claiming deductions that you can't legally claim. Inaccurately calculating your deductions by a few dollars or forgetting to include a few hundred dollars in bonuses would likely not be fraud. You have a right to demonstrate that your underpayment was due to a miscalculation rather than fraud. Further, the penalty only applies if you underestimate your tax burden by either $5,000 or 10 percent of the total amount owed, whichever is the greater amount of money. So, for example, if you only owed $1,000 and underestimated your taxes by $100, the penalty would not apply.

The IRS can assess interest on late payments as well as underpayment penalties. Interest rates are set on a quarterly basis. As of November 2012, the interest rate was the federal short-term interest rate plus three additional percentage points.