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How do I Avoid an Underpayment Penalty?

Q: I had to pay a bundle with my tax return, and my AARP preparer said I would probably be assessed an underpayment penalty. What is this all about, and how can I avoid it next year?

A: We are expected to pay most of our taxes throughout the year and not to wait until we file our tax returns. If we have too large a balance due when we file our returns, the IRS can assess a penalty for not paying enough during the year.

If you have income which is not subject to withholding taxes, such as interest, dividends, and pensions, consider paying estimated taxes during the course of the year. Estimate what your unpaid tax may be for 2008, then pay 1/4 of it on April 15, June 15, Sept. 15, 2008, and Jan. 15, 2009. Complete form 1040-ES to submit with each payment.

You will not be subject to an underpayment penalty in any of the following circumstances:

 

  • If your withholding and payments are at least as much as your total 2007 taxes (110 percent of your 2007 taxes if your income is more than $150,000).

 

  • If the balance due on your tax return is not more than 10 percent of your 2008 total taxes, assuming you've made your estimated payments on time.

 

  • Your total 2008 taxes due when you file your return in April 2009, less any withholding, is less than $1,000.

 

  • Your 2008 taxes, in total, are less than $1,000.

 

Some people don't like to pay with their returns, so they try and make estimated payments large enough to cover their entire tax liability. Others like to keep their money as long as possible and only try to pay enough to avoid an underpayment penalty, even if they wind up paying a sizeable amount with their return. It’s your choice.

These questions are actual inquiries submitted by taxpayers to our AARP Tax-Aide Program. The AARP Tax-Aide Program is a volunteer-run, free tax-preparation and assistance program offered to low- and middle-income taxpayers with special attention to those age 60 and older. Our volunteers are trained and IRS-certified to understand individual federal-tax issues. Our volunteers provide tax assistance as a public service and cannot guarantee the accuracy of the information provided.

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