Underpayment and Understatement Tax Penalties: Rates and Abatement

The IRS underpayment and understatement penalties are two different charges: one hits you for not paying enough tax during the year through withholding or estimated payments, and the other hits you for reporting too little tax on the return you file. The underpayment penalty works like interest on the shortfall. The understatement penalty is a flat 20% of the extra tax you owe, rising to 75% if the IRS proves fraud. Both are avoidable if you know the thresholds and safe harbors.

A quick boundary before going further: these penalties are separate from the failure-to-file and failure-to-pay penalties that apply when you miss the April deadline or don’t pay the balance shown on your return. Those are their own charges and can stack on top of what’s covered here.

What Triggers the Underpayment Penalty

The federal tax system runs pay-as-you-go. W-2 employees satisfy it through withholding. Everyone else — the self-employed, freelancers, retirees living on investment income, anyone with significant capital gains — has to send quarterly estimated payments. When those payments fall short, the IRS treats the gap as money you borrowed and charges you accordingly under IRC Section 6654.¹

For the 2026 tax year, estimated payments are due April 15, 2026; June 15, 2026; September 15, 2026; and January 15, 2027. The label “quarterly” is misleading; the second installment falls only two months after the first. You can skip the January payment if you file your 2026 return and pay in full by February 1, 2027.²

Safe Harbors That Block the Penalty

You don’t have to guess your tax bill to the dollar. Meeting any one of the safe harbors below shields you from the penalty, even if you end up owing a large balance at filing time.

Your withholding and estimated payments cover at least 90% of the tax shown on your 2026 return.³
You pay at least 100% of the tax shown on your 2025 return, regardless of what happens to your 2026 income.³
If your 2025 adjusted gross income was over $150,000 ($75,000 for married filing separately), the prior-year threshold rises to 110%.³
Your total tax minus withholding and credits leaves a balance under $1,000.³

The prior-year safe harbor is the practical winner when your income spikes. A freelancer who earned $80,000 in 2025 and $200,000 in 2026 can lock out the penalty by paying 110% of the 2025 liability across the four deadlines. You’ll still owe a substantial balance in April, but no penalty rides along with it.

One further exception is easy to miss: if you had zero tax liability in the prior year and were a U.S. citizen or resident for the full year, you owe no estimated tax penalty no matter how much you make in the current year.⁴

When Your Income Arrives Unevenly

The standard system assumes roughly equal income each quarter. That penalizes anyone whose earnings cluster in one part of the year — real estate agents who close most deals in summer, retailers with holiday income, consultants with lumpy project payments. The annualized income installment method lets you calculate each quarterly payment on income actually received during that period.⁵ You complete Schedule AI on Form 2210 and check box C in Part II. The math is more work, but it often erases the penalty entirely.

The 20% Accuracy-Related Penalty

The understatement penalty is the second charge in the pair, and it works differently. Under IRC Section 6662, the IRS imposes a flat 20% penalty on underpayments caused by negligence, substantial understatement of income tax, and several other categories of inaccuracy.⁶ This is the penalty most taxpayers encounter after an audit or an automated matching notice turns up errors.

Negligence means failing to make a reasonable attempt to follow the rules — no adequate records, deductions you can’t back up, ignoring IRS regulations.⁷ The bar is low. You don’t have to intend anything wrong; being careless is enough.

An understatement becomes “substantial” once it crosses a dollar threshold. For individuals, the understatement must exceed the greater of 10% of the correct tax or $5,000.⁶ So a return showing $30,000 in correct tax has a threshold of $5,000, because 10% of $30,000 is only $3,000 and the rule takes whichever number is bigger.

C corporations follow a different formula: the understatement is substantial if it exceeds the lesser of 10% of the correct tax (with a $10,000 floor) or $10 million.⁷ The 20% applies to the portion of the underpayment tied to the understatement, and it stacks on top of interest on the unpaid balance.⁸

When the Penalty Jumps to 75%

If the IRS determines that an underpayment was due to fraud rather than negligence or honest error, IRC Section 6663 raises the penalty to 75% of the fraudulent portion. The IRS carries the initial burden of proving fraud on some part of the underpayment. Once it does, the entire underpayment is presumed fraudulent, and the taxpayer has to rebut that presumption by a preponderance of the evidence.⁹ On joint returns, the penalty only reaches the spouse whose conduct was fraudulent.

Cutting an Understatement Down Before It Counts

Section 6662(d) offers two ways to shrink or eliminate a substantial understatement, both worth knowing before you file.

The first is substantial authority. If existing statutes, regulations, court cases, or IRS guidance meaningfully support your position, the piece of the understatement tied to that position doesn’t count toward the threshold.⁶ Substantial authority is a higher standard than “reasonable basis” but lower than “more likely than not.”

The second is adequate disclosure. Attach Form 8275 to your return, spell out the relevant facts, and a position with a “reasonable basis” won’t count toward the understatement even if the IRS disagrees with your treatment in the end. Reasonable basis is a lower bar than substantial authority, but it still reflects a “relatively high standard of tax reporting” — not merely arguable.¹⁰

Disclosure has limits. It won’t protect you from the negligence penalty, from penalties on tax shelter items, from valuation misstatements, or from transactions lacking economic substance.¹⁰ And if you never kept records to back up the position, disclosure on a form won’t save you. For an aggressive-but-supportable position on ambiguous law, filing Form 8275 with the original return is one of the strongest defensive moves available.

How the Two Penalties Are Calculated

The underpayment and accuracy-related penalties use different formulas, which confuses people who see both on the same notice.

The estimated tax underpayment penalty behaves like interest. The rate equals the federal short-term rate plus three percentage points, adjusted every quarter.¹¹ For the first quarter of 2026, that rate is 7%.¹² It runs separately for each installment period, calculated daily from the date the payment was due until the date it’s paid or the filing deadline arrives, whichever comes first.³ You usually don’t need to compute it yourself; the IRS calculates and bills you. You can run the numbers on Form 2210 if you want to include the penalty on your return, claim a waiver, or use the annualized income method.⁴

The accuracy-related penalty is simpler math: 20% of the underpayment attributable to the understatement, negligence, or other qualifying inaccuracy.⁸ Multiple errors on one return get combined and taxed at the same 20%. The penalty sits on top of the underlying tax and any interest the IRS charges; it doesn’t replace them.

Getting a Penalty Removed

The IRS removes penalties more often than most people expect. Three paths are available, and you can request any of them by phone using the number on your notice.¹³

First-Time Abatement

If you filed all required returns for the past three years and weren’t assessed any penalties during that period, you likely qualify for the First-Time Abate (FTA) waiver.¹⁴ FTA is an administrative policy, not a statute. Call and ask. The IRS will apply it even if you called to argue reasonable cause and happened to qualify for FTA instead.¹³ You don’t need to have paid the tax in full to request FTA, though the failure-to-pay penalty will continue accruing until the balance is settled.

Reasonable Cause

When FTA isn’t available, reasonable cause is the next argument: circumstances beyond your control kept you from filing or paying on time. The IRS decides these case by case. Situations that regularly succeed include natural disasters, serious illness or death in the immediate family, inability to obtain necessary records, and system failures that blocked timely electronic filing.¹³

For accuracy-related penalties, the analysis shifts. The IRS looks at how much effort you made to report correctly, the complexity of the issue, your level of tax knowledge, and whether you sought professional help.¹³ Reliance on a qualified tax advisor who had all the relevant facts can support the argument, though it isn’t a guarantee.

Filing Form 843 for a Refund or Written Claim

If you’ve already paid the penalty and want it back, or the IRS turned down your phone request, file Form 843, Claim for Refund and Request for Abatement. Line 7 states your reason; Line 8 is where you explain the facts in detail with supporting documentation. The deadline is generally three years from the date you filed the original return or two years from the date you paid the tax, whichever is later.¹⁵ Miss that window and the IRS won’t consider the claim.

1
Office of the Law Revision Counsel. 26 U.S.C. 6654
2
Internal Revenue Service. 2026 Form 1040-ES Estimated Tax for Individuals
3
Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty
4
Internal Revenue Service. Instructions for Form 2210
5
Internal Revenue Service. Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts
6
Office of the Law Revision Counsel. 26 U.S.C. 6662
7
Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments
8
Internal Revenue Service. The Section 6662(e) Substantial and Gross Valuation Misstatement Penalty
9
Office of the Law Revision Counsel. 26 U.S. Code 6663 – Imposition of Fraud Penalty
10
Internal Revenue Service. Instructions for Form 8275 (Disclosure Statement)
11
Internal Revenue Service. Quarterly Interest Rates
12
Internal Revenue Service. Interest Rates Remain the Same for the First Quarter of 2026
13
Internal Revenue Service. Penalty Relief for Reasonable Cause
14
Internal Revenue Service. Administrative Penalty Relief
15
Internal Revenue Service. Instructions for Form 843 (Claim for Refund and Request for Abatement)