Is it worth taking an underpayment penalty on your taxes...

[Davids]

As I understand if you owe more than $1,000 on your federal tax return and do not make estimated quarterly payments then the IRS charges an underpayment penalty. From what I have seen it appears the underpayment penalty is around 1-1.5% of the total owed. I am wondering if it is better off to adjust the W4 then of course invest the extra funds even though it should have been taxed right away and just take the penalty since more than likely one would earn more than that on the market. Maybe I am misunderstanding, with people always saying try to adjust your W4 so that your you do not owe anything additional when you file your federal return but if the underpayment penalty is at best maybe 1.5% (from what I have seen) then is it worth the risk just to take the penalty?

[lise]

As a freelancer my income/deductions vary wildly.  I make the first three quarterly payments.  The last couple of years I have ended up paying a minimal underpayment penalty.  It doesn't worry me too much. I would rather underpay than have IRS have money they shouldn't and end up with a refund.

[curler]

Based on line 15 of http://www.irs.gov/pub/irs-pdf/f2210.pdf, it appears the penalty is 1.995%, so nearly 2%. So I guess the question is do you want to borrow money at 2% interest to invest?  Personally, I don't like borrowing money to invest, so I wouldn't.  But maybe you have more risk tolerance than I do.  Also, the IRS frowns upon doing this.  See, http://www.irs.gov/taxtopics/tc753.html "lock-in letters" where they can stop you from doing so.  I'm not 100% sure of this, but I have heard that the IRS can be less forgiving if you need them to waive something for you in the future if you generally file late/under withhold.

[forummm]

I wouldn't do it. But note that you can avoid a penalty if you pre-pay the amount of tax you owed last year.

[Mr. Green]

It is the greater of more than $1,000 or 10% of your total tax owed. So if your tax bill for the year is $25,000 you can owe up to $2,500 before the penalty kicks in.

[johnny847]

It is the greater of more than $1,000 or 10% of your total tax owed. So if your tax bill for the year is $25,000 you can owe up to $2,500 before the penalty kicks in.

forumm is correct. The IRS lists five ways to avoid underpayment penalties, and you have listed two of them.

The IRS lists three other ways to avoid the underpayment penalty:

• The total of your withholding and timely estimated tax payments was at least as much as your previous tax year's tax [as forumm mentioned].
• You did not have a tax liability for the previous tax year [I don't know why the IRS explicitly states this one, this is just a direct result of the above]
• You did not have any withholding taxes and your current year tax (less any household employment taxes) is less than $1,000 [This is just a direct result of the underpaid by less than $1k provision, so I don't know why the IRS explicitly states this one either]