Accidentally underpaying taxes can happen to anyone. Whether due to a calculation error, incorrect withholding, or misunderstanding tax laws, underpaying taxes can result in penalties, interest charges, and possible IRS action. However, if you act quickly and understand your options, you can resolve the issue without severe consequences.
This topic explains what happens when you underpay taxes, how to fix the problem, and how to avoid it in the future.
Why Do People Accidentally Underpay Taxes?
There are several reasons why taxpayers may unknowingly underpay their taxes, including:
- Incorrect Tax Withholding – Employees who do not withhold enough taxes from their paycheck may owe money at tax time.
- Self-Employment Taxes – Freelancers and business owners may miscalculate their quarterly estimated tax payments.
- Unreported Income – Failing to report additional sources of income, such as side jobs, investments, or rental income, can lead to underpayment.
- Claiming Too Many Deductions or Credits – If you incorrectly claim tax credits or deductions, your tax liability may be higher than expected.
- Math or Filing Errors – Simple mistakes in tax calculations or forgetting to report income can result in an underpayment.
What Happens If You Underpay Your Taxes?
The IRS takes tax underpayment seriously, but the consequences vary depending on the amount owed, reason for underpayment, and how quickly you resolve the issue.
1. The IRS Will Notify You
If the IRS determines that you have underpaid your taxes, they will send you a notice of underpayment. This may come in the form of a:
- CP14 Notice – This is the first letter informing you of unpaid taxes. It outlines the amount owed, including penalties and interest.
- CP501 or CP503 Notice – If you ignore the first notice, you may receive a follow-up letter demanding payment.
2. You May Owe Interest on the Unpaid Amount
The IRS charges interest on underpaid taxes starting from the original due date of the tax return. The interest rate is typically based on the federal short-term rate plus 3% and is adjusted quarterly.
For example, if you underpaid $1,000 in taxes and the IRS interest rate is 5%, you will owe $50 in interest after one year.
3. You Could Face Underpayment Penalties
The IRS may charge a penalty if you underpay taxes by a significant amount. Common penalties include:
- Failure-to-Pay Penalty – Typically 0.5% per month on unpaid taxes, up to a maximum of 25%.
- Underpayment Penalty – If you fail to pay at least 90% of your total tax bill, the IRS may impose an underpayment penalty. This is usually 0.5% to 1% of the unpaid amount.
- Estimated Tax Penalty – If you are self-employed and fail to make adequate quarterly estimated payments, you may owe additional penalties.
4. The IRS May Seize Your Refund
If you have a tax refund due in the following year, the IRS can apply it to your outstanding tax debt instead of issuing a refund check. This is called an offset and helps reduce your tax balance automatically.
5. Tax Liens and Wage Garnishment May Occur
If you ignore IRS notices and fail to pay your underpaid taxes, the IRS may take more aggressive collection actions, such as:
- Tax Liens – The IRS may place a legal claim on your assets, making it difficult to sell property or get credit.
- Wage Garnishment – The IRS can withhold a portion of your paycheck to cover unpaid taxes.
- Bank Levies – The IRS may freeze and withdraw funds from your bank account to recover the owed amount.
These actions usually occur only after repeated notices and failure to respond.
How to Fix an Accidental Tax Underpayment
If you realize you underpaid your taxes, there are several steps you can take to correct the mistake and minimize penalties.
1. Pay the Amount Owed as Soon as Possible
The fastest way to fix an underpayment is to pay the missing amount in full. You can:
- Use the IRS Direct Pay system to make a payment online.
- Set up an Electronic Funds Withdrawal through your bank.
- Mail a check or money order to the IRS.
The sooner you pay, the less interest and penalties you will owe.
2. File an Amended Tax Return (If Necessary)
If the underpayment was due to an error on your tax return, you may need to file an amended return (Form 1040-X) to correct the mistake. This can prevent further penalties and ensure your records are accurate.
3. Request a Payment Plan If You Can’t Pay in Full
If you can’t afford to pay the full amount at once, the IRS offers installment agreements that allow you to pay over time. Options include:
- Short-Term Payment Plan – If you owe less than $100,000, you may qualify for a 180-day extension to pay in full.
- Long-Term Installment Agreement – If you owe less than $50,000, you can apply for a monthly payment plan.
These plans prevent aggressive collection actions as long as you make timely payments.
4. Request Penalty Abatement
If your underpayment was due to reasonable cause (such as a medical emergency or natural disaster), you can request a penalty abatement. The IRS may waive penalties if you have a valid reason and a good history of tax compliance.
5. Adjust Your Withholding or Estimated Payments
To prevent underpayment in the future:
- Employees: Use the IRS Tax Withholding Estimator to adjust your W-4 form. Increasing your tax withholding will help cover your tax liability throughout the year.
- Self-Employed Individuals: Ensure that you make quarterly estimated tax payments on time to avoid penalties.
How to Avoid Underpaying Taxes in the Future
To prevent accidental tax underpayment, consider these strategies:
1. Review Your Tax Withholding Regularly
If you receive a raise, change jobs, or have additional income, update your W-4 form to adjust your tax withholding.
2. Keep Track of All Sources of Income
Ensure you report all taxable income, including:
- Freelance or side gig earnings.
- Investment income (stocks, dividends, or cryptocurrency).
- Rental property income.
Using tax software or consulting a tax professional can help you accurately track income and deductions.
3. Pay Estimated Taxes If You Are Self-Employed
If you are a freelancer, contractor, or small business owner, make quarterly estimated tax payments to avoid underpayment penalties. The due dates are:
- April 15
- June 15
- September 15
- January 15 (of the following year)
4. Use Tax Software or a Professional
Tax preparation software like TurboTax, H&R Block, or TaxAct can help ensure accurate calculations. If you have complex taxes, hiring a tax professional can minimize errors and maximize deductions.
Accidentally underpaying taxes can result in interest charges, penalties, and potential IRS enforcement actions. However, by paying what you owe quickly, setting up a payment plan if needed, and adjusting your withholding or estimated payments, you can minimize the impact.
Staying proactive with tax planning, tracking income, and using professional tax services can help you avoid future underpayments and keep you in good standing with the IRS.