IRS Increases Underpayment Penalty to 7% – How to Avoid Extra Taxes in 2025

Understanding the Increased IRS Penalty for Underpayment in 2025

Taxes are something we all have to pay, and it's important to do it right. If you don’t pay enough taxes throughout the year, the IRS charges you a penalty. This year, the penalty for underpayment has gone up to 7%. That means if you don’t pay enough, you could owe even more money when tax season comes. Let’s break this down so you can understand what this means and how you can avoid it.

What Is an Underpayment Penalty?

When you earn money, the government expects you to pay taxes on it throughout the year. Most people do this through paycheck withholdings or estimated tax payments. If you don’t pay enough during the year, the IRS charges you a fee called an underpayment penalty. This is their way of making sure everyone pays their fair share on time.

Why Did the IRS Increase the Penalty?

The IRS adjusts penalties based on interest rates and economic conditions. With rising interest rates, they have decided to increase the underpayment penalty to 7%. The goal is to encourage taxpayers to make their payments on time and in the right amounts.

Who Does This Affect?

This penalty increase affects:

• Self-employed workers who pay estimated taxes each quarter.

• Freelancers and gig workers who don’t have taxes automatically taken out of their income.

• Business owners who need to handle their own tax payments.

• Employees with too little withheld from their paychecks.

How to Avoid the Underpayment Penalty

The best way to avoid this penalty is to make sure you are paying enough taxes throughout the year. Here are some simple steps to help you stay on track:

1. Adjust Your Withholding

If you work for a company, check your W-4 form. This form tells your employer how much tax to take from your paycheck. If you often owe taxes at the end of the year, consider adjusting your withholdings to have more taken out each paycheck.

2. Make Estimated Tax Payments

If you are self-employed or don’t have enough withheld from your paycheck, you should make estimated tax payments every quarter. These payments are due in April, June, September, and January of the following year. You can use IRS Form 1040-ES to calculate how much you need to pay.

3. Use the Safe Harbor Rule

The IRS has a rule that helps taxpayers avoid penalties. If you pay at least 90% of your current year’s tax or 100% of last year’s tax (110% for higher earners), you won’t get hit with a penalty, even if you still owe some money at tax time.

4. Keep Track of Your Income

If your income changes throughout the year, make sure you adjust your tax payments accordingly. A big raise, a new freelance job, or extra income from investments could mean you owe more taxes than before.

5. Set Aside Money for Taxes

A good rule of thumb for self-employed workers is to set aside 25-30% of their income for taxes. This way, when it’s time to pay, you already have the money saved and won’t have to scramble to find it.

What Happens If You Underpay?

If you don’t pay enough during the year, the IRS will calculate how much you should have paid and charge you interest on the difference. Since the penalty rate is now 7%, the more you underpay, the more you will owe in penalties.

How to Check If You Owe a Penalty

You can use the IRS Tax Withholding Estimator online to see if you are on track. If you find out that you haven’t paid enough, you can make a payment before the next due date to reduce or eliminate the penalty.

What If You Can’t Pay Your Taxes?

If you are struggling to pay your taxes, don’t ignore it. The IRS offers payment plans that allow you to pay over time. It’s always better to set up a payment plan than to ignore your tax bill and face bigger penalties later.