Federal income taxes are supposed to work as a "pay-as-you-go" system, in which you pay taxes regularly as you earn money. Taxpayers have some control over this process, whether they draw a paycheck (through witholding) or are self-employed (through quarterly estimated payments). The annual return leads to a balancing of the account, when you either claim a refund if you overpaid or send the IRS a check if you paid too little. If you don't pay in a sufficient amount throughout the year, you may be subject to a penalty.
Form 1040 and Estimated Payments
You can adjust withholding by filing a new W-4 with your employer; the fewer allowances you claim, the more the employer withholds. Each year, you report taxes already paid in for the previous year on Form 1040, line 62. On this line, you enter the amount if withholding as stated on your W-2s and 1099s. On line 63, you report any estimated tax payments made. The IRS recommends that to avoid the underpayment penalty, you make estimated payments in four equal amounts throughout the year; the due dates are April 15, June 15, Sept. 15 and Jan. 15.
Charges for underpayment of taxes consist of interest and penalties. The IRS charges a variable interest rate on past-due taxes and underpayments, equal to the federal funds (short-term) interest rate plus 3 percent. The rate is set every three months by the agency and continues to accrue on any outstanding balances.
If the IRS determines you underpaid your taxes, it calculates the amount you should have paid and did not, and levies a penalty of 0.5 percent of that amount for every month the tax goes unpaid, starting with the date on which it was due (in most cases, April 15 of the following year). If you fail to begin repayments, and the agency is forced to send out reminder notices, it can increase the rate up to 25 percent, compounded monthly. The IRS also will penalize any false information provided on a W-4 with penalties and possible criminal prosecution.
Waiver of Penalty
The IRS will not levy penalties for underpayments if the balance owed on the 1040, after figuring in withholding and credits, is less than $1,000. You may also be excused if you have a reasonable cause for not paying a sufficient amount, and if you retired on or after your 62nd birthday for the tax year, or the preceding year. The IRS waives the underpayment penalty if the shortfall was caused by a natural disaster, accident, illness, or some other circumstance that reasonably prevented you from making full payment. You would claim these exemptions by writing a letter to the IRS explaining the circumstances and enclosing it with your return.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.