Tax Underpayment Penalty: A Costly Oversight

This article may literally save you — or someone you know — tens of thousands of dollars. If you, your family, or your friends sold stocks, a business, or a house this year, you might already be on the hook for a tax underpayment penalty, even if you plan to file and pay everything by April.

The reason? The IRS tax system is Pay-As-You-Go, not pay-when-you-file. Any taxable event — such as realizing capital gains — is expected to be paid during the quarter it happens. If those taxes aren’t paid on time, you could face penalties that quietly add up to thousands.

Case Study: The Cost of Honest Negligence

This was the year your friends finally upgraded their home. To prepare the $500,000 down payment, they sold some stock and other investments in March 2025, realizing a $300,000 capital gain.

That gain triggered about $60,000 in federal and $24,000 in state capital gains taxes — all technically due in the first quarter of 2025. But like many others, they planned to take care of it the following April when filing their 2025 return.

By that time, however, the IRS will assess a 7% APR underpayment penalty on the unpaid amount — costing them several thousand dollars that could have been easily avoided. Nothing dishonest was done — just an honest oversight of how the “pay-as-you-go” rule works.

Why the Penalty Happens?

Tax underpayment penalties occur when you don’t pay enough tax during the year through withholding or estimated quarterly payments. It often surprises people with irregular or one-time taxable events, such as:

• Selling property, stock, or business interests

• Exercising or vesting stock options or RSUs

• Receiving a large bonus or non-wage income

• Having substantial investment income without withholding

Even though you have until mid-April to file, the IRS expects payment as income is earned or realized.

How to Avoid It?

The IRS generally assesses an underpayment penalty if you owe more than $1,000 in tax after subtracting withholdings and credits. Fortunately, there are several ways to prevent that:

1. Use the Safe Harbor Rule: You can generally avoid penalties if you’ve paid:

   • 90% of your current year’s tax liability, or

   • 100% of your prior year’s total tax (110% if your adjusted gross income exceeds $150,000).

2. Adjust Withholding Before December: If you’re employed, increase your W-4 withholding now. The IRS treats withheld taxes as if they were paid evenly throughout the year — even if you make the change late in the year.

3. Make a Catch-Up Estimated Payment: You can still make a fourth-quarter estimated payment by January 15 of the following year to cover additional tax obligations.

4. Offset Gains Strategically: Consider tax-loss harvesting, charitable giving, or maximizing retirement contributions to reduce your taxable income.

The INTEG Perspective

At INTEGFI, we encourage clients to take a year-end tax review seriously — not just to avoid penalties, but to strengthen long-term tax efficiency. Whether it’s selling an asset, exercising stock options, or realizing a large gain, we model the tax impact and recommend actions before December 31 to keep your plan compliant and optimized.

Many penalties stem from missed timing, not missed money — and that’s entirely preventable with proactive planning.

Taxes aren’t a once-a-year event; they happen all year long. The year-end review could save you from unnecessary penalties and protect more of what you’ve earned.

Disclaimer

This article is for educational and informational purposes only and is based on a hypothetical case study. It does not constitute tax, legal, or financial advice. Tax laws are complex and subject to change — you should consult a qualified tax professional regarding your specific situation.