Underpayment Penalty

Underpayment Penalty

A penalty that a taxpayer must pay if he/she fails to pay enough in estimated taxes and withholding. In order to reduce the incentive for persons and companies to pay taxes late, the IRS has instituted an underpayment penalty. In order to avoid the underpayment penalty, one must either pay 100% of his/her tax liability for the previous year or 90% of the liability for the current year.
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California law currently has a 20 percent underpayment penalty for understatements in excess of $1 million, which in many cases results in taxpayers overpaying their taxes to avoid the underpayment penalty.
An estimated tax underpayment penalty may further increase the taxpayer's bottom-line shock.
First, it would impose a strict liability underpayment penalty of 30 percent on transactions lacking economic substance.
The underpayment penalty will not apply if the taxpayer's total tax liability is less than $500 or he has paid in at least 90% of the current year's tax or he has paid in an amount equal to at least 100% of the prior year's tax if a return was filed for that year.
Current law effectively requires large corporations to overpay their estimated taxes, without the benefit of interest, or in order to avoid an underpayment penalty under section 6655 of the Code.
The estimated tax provision would raise, for corporations reporting annual income in excess of $1 million, the amount of money companies must pay quarterly to avoid an underpayment penalty.
While owing taxes isn't necessarily a bad thing, taxpayers who ended up owing a considerable amount may want to adjust their withholdings so that they are paying more during the year and avoiding any underpayment penalty.
Any tax not paid during the year (either through federal income tax withholding from an employer or estimated tax payments) is subject to an underpayment penalty.
California law has a 20 percent underpayment penalty for understatements in excess of SI million which in many cases results in taxpayers to overpay their taxes to avoid the underpayment penalty.
In addition, the courts upheld a 20% substantial underpayment penalty under section 6662(a).
This change overrides Technical Advice Memorandum 8802003 which held the substantial underpayment penalty applied even though no return had been filed.
In an area such as transfer pricing, where "20/20 hindsight" is often applied by IRS examiners, TEI believes that the reasonable-cause exception should be interpreted to mitigate the severe underpayment penalty that may result from second-guessing a taxpayer's analysis and interpretation of complex factual data.