How to Avoid Underpayment Penalties

If you're required to make estimated tax payments and miss them, the IRS charges a 7% annual interest rate on underpayments (as of Q2 2025), compounded daily. And since penalties aren’t deductible, the after-tax hit often feels closer to 10–11% in real terms.

 How This Plays Out in 2025

Let’s say you owe $40,000 in total federal tax for the year, and you make no estimated payments at all.

Under IRS rules, quarterly payments of $10,000 would be due by:

• April 15

• June 17

• September 16

• January 15 (2026)

Here’s what your penalty could look like for Q1 alone:

• Amount underpaid for Q1: $10,000

• Interest rate (annual): 7%

• Interest period (April 15 to June 17): ~63 days

• Daily rate: 0.01918%

• Penalty for Q1 underpayment: ~$121

That’s just for the first quarter. If you miss all four payments and owe the full $40,000 in April 2026, the total penalty could easily exceed $500–$700, depending on when you pay and compounding factors.

Smart Ways to Fix It (Even Late in the Year)

The IRS treats withholding (from W-2s or retirement distributions) as if it was spread evenly across all four quarters—regardless of when it actually happens. This gives you powerful flexibility:

• S or C Corp bonus: Pay yourself a bonus in December and withhold extra taxes to “catch up”

• W-2 job: Adjust your withholding now to spread more tax across remaining paychecks

• IRA “rollover-and-replace”: Take a distribution, withhold 100% for taxes, then redeposit the full amount within 60 days to avoid tax on the withdrawal

These methods can help meet the IRS safe harbor rules and eliminate penalties, often with less hassle than quarterly payments.

Let me know if you'd like a projection based on your 2025 income or help setting up one of these strategies. It's not too late to course-correct!