Tax Underpayment: How the Penalty Is Calculated, Waived, and Avoided

The tax underpayment penalty is what the IRS adds to your bill when your withholding and estimated payments during the year fell short of what the law required. It works like interest on the shortfall, accruing quarter by quarter at a rate the IRS resets every three months: 7% for the first quarter of 2026 and 6% for the second. You avoid it entirely by meeting one of the safe harbors — paying at least 90% of your current-year tax or 100% of last year’s tax (110% if your prior-year adjusted gross income topped $150,000) — or by owing less than $1,000 after withholding and refundable credits.¹

Who Gets Hit With It

The IRS expects tax to come in as you earn income, not in one lump at filing time. Employees usually handle this through payroll withholding without thinking about it. Freelancers, business owners, retirees drawing from investments, and anyone with significant income that isn’t run through a W-2 have to send the money themselves as quarterly estimated payments. When the combined total of your withholding and estimates doesn’t keep pace with your actual liability, the penalty applies.

Three ways to stay clear of it, and you only need one:

Your payments during the year covered at least 90% of your current-year tax.
Your payments covered 100% of the tax shown on last year’s return, so long as that return covered a full 12 months. If your AGI last year was over $150,000 ($75,000 if married filing separately), that threshold is 110%, not 100%.
Your total tax minus withholding and refundable credits comes out to less than $1,000.¹

That $1,000 floor catches a lot of people who assume any shortfall triggers a penalty. If you’re close to the line, run the numbers before writing yourself off.

How the Charge Is Calculated

The penalty is not a flat fine. It accrues daily on whatever you should have paid but didn’t, from the date each quarterly payment was due until the date you actually pay. The rate resets each quarter using a formula: the federal short-term rate plus three percentage points.²

For 2026, that comes out to 7% for January through March and 6% for April through June.² Rates for the third and fourth quarters had not been announced at the time of writing.

Each quarterly period is treated independently. A large catch-up payment in December doesn’t erase interest that built up on a missed April installment. Even if your annual total ends up exactly right, paying it late or lumpy still produces a penalty for the quarters you were short. The interest compounds daily, so small gaps left alone for months become meaningful amounts.²

The Quarterly Deadlines

The tax year splits into four payment periods, each with its own due date:

First quarter (January 1–March 31): payment due April 15, 2026
Second quarter (April 1–May 31): payment due June 15, 2026
Third quarter (June 1–August 31): payment due September 15, 2026
Fourth quarter (September 1–December 31): payment due January 15, 2027

If any date lands on a weekend or federal holiday, the deadline shifts to the next business day.³

Notice the periods aren’t equal three-month chunks. The second one covers only two months. That trips up people who divide their annual estimate by four and send identical payments. If you land a big freelance contract, sell investments at a gain, or get a large bonus during a specific period, the IRS expects that period’s payment to reflect the spike.

When Your Income Arrives Unevenly

If most of your income shows up late in the year — a seasonal business, a fourth-quarter capital gain, a year-end bonus contract — the standard calculation punishes you for underpaying in quarters when you hadn’t earned the money yet. The annualized income installment method fixes this. Instead of assuming you earned at a steady pace, it recalculates your required payment for each quarter based on what you actually earned through the end of that period.

You elect it by completing Schedule AI as part of Form 2210. Once you elect it for any quarter, you have to use it for all four. Income and deductions for each period follow your accounting method; for most individuals on the cash method, that means income actually received and deductions actually paid during the period.⁴ If 80% of your income arrived between September and December, this method can dramatically shrink what would otherwise be a significant penalty.

When the IRS Will Waive It

The bar for a waiver is higher than most people expect, and one common assumption is wrong: the first-time penalty abatement program does not cover estimated tax underpayments. It applies only to failure-to-file and failure-to-pay penalties.⁵

The waivers that do exist:

Casualty, disaster, or unusual circumstance. The IRS can remove the penalty if applying it would be against equity and good conscience given a federally declared disaster, a serious casualty, or another extraordinary event. If you already received a notice, follow its instructions to request relief by phone or by filing Form 843.⁶
Recent retirement or disability. If you retired after reaching age 62, or became disabled, in the tax year the estimated payments were due or the year immediately before, the IRS can waive the penalty. You must show the underpayment was due to reasonable cause and not willful neglect. Request it by filing Form 2210 with a statement explaining the circumstances and supporting documentation.¹

For the reasonable cause standard, the IRS evaluates case by case. You need to explain what happened, how it kept you from paying, and what you did to try. Hospital records, court records, or evidence of a natural disaster all strengthen the request.⁷

Do You Have to File Form 2210

Usually, no. The IRS will calculate the penalty for you and send a bill. Filing Form 2210 yourself is optional in most cases.⁸

You do need to file it when you’re requesting one of the waivers above, using the annualized income installment method, or trying to show that you owe a lower penalty than the IRS would compute using the standard method. If you complete the form, you’ll need your prior-year return, current-year W-2s showing withholding, and records of every estimated payment you made, with exact dates and amounts.

If You Already Owe It

Once you have the number, several ways to pay:

IRS Direct Pay. Free transfers from a bank account, capped at $10 million per transaction.⁹
Electronic Federal Tax Payment System (EFTPS). Free but requires pre-registration. Often the tool of choice for business owners who pay frequently.
Credit or debit card, through authorized third-party processors that charge their own fees.¹⁰
Check or money order mailed with Form 1040-V.

Online payments generate an immediate confirmation number. Keep it with your tax records.

If you can’t pay in full, the IRS offers two payment plans. A short-term plan gives you up to 180 days with no setup fee, provided you owe less than $100,000 in combined tax, penalties, and interest. A long-term installment agreement covers balances of $50,000 or less with setup fees between $22 and $178, depending on whether you apply online and whether you use automatic bank withdrawals. Taxpayers with adjusted gross income at or below 250% of the federal poverty level may have setup fees waived.¹¹

Interest and penalties continue accruing on any unpaid balance while you’re on a plan, so every extra month adds to the total.

Preventing It Next Year

If you’re an employee who got hit with a penalty, you almost certainly have too little coming out of each paycheck. The IRS Tax Withholding Estimator at irs.gov walks you through your income, deductions, and credits, then produces a completed W-4 you hand to your employer or pension administrator.¹² Running it after any major change — new job, marriage, new side income, retirement — is the single most effective move.

For self-employment or other income without withholding, quarterly estimates are the only route. The 2026 Form 1040-ES worksheet helps you project the year and split it into four payments.³ If your income is unpredictable, the safest play is paying 100% of last year’s tax (110% if your prior-year AGI was over $150,000), split evenly across the four deadlines. You’ll meet the safe harbor regardless of what this year actually brings. You might overpay and get a refund, but you won’t owe a penalty.

One boundary worth flagging: most states with an income tax impose their own underpayment penalties, with rates that vary. Meeting the federal safe harbor doesn’t automatically protect you at the state level, so check your state’s rules separately.

1
Office of the Law Revision Counsel. 26 USC 6654 – Failure by Individual to Pay Estimated Income Tax
2
Internal Revenue Service. Quarterly Interest Rates
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Internal Revenue Service. 2026 Form 1040-ES – Estimated Tax for Individuals
4
Internal Revenue Service. Instructions for Form 2210 (2025)
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Internal Revenue Service. Administrative Penalty Relief
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Internal Revenue Service. Penalty Relief Due to Statutory Exception
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Internal Revenue Service. Penalty Relief for Reasonable Cause
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Internal Revenue Service. Instructions for Form 2210 – Underpayment of Estimated Tax by Individuals, Estates, and Trusts
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Internal Revenue Service. Direct Pay with Bank Account
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Internal Revenue Service. Pay Your Taxes by Debit or Credit Card or Digital Wallet
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Internal Revenue Service. Payment Plans; Installment Agreements
12
Internal Revenue Service. Tax Withholding Estimator