How does the underpayment of IRS federal income tax work?

Question

Say for instance that my 2006 taxes are fully paid.
Yet for 2007 after I file for my return next year in april that it turns out I underpaid by 2000 dollars.

Will I owe the IRS a penalty for this?

Second senario.

Say that for 2006 my taxes are fully paid.
But for 2007 I am also getting a tax return of around 100 dollars because of all my deductions such as charity, real estate tax and interest etc. Even though I technically underpaid the IRS before the deductions, after the deductions are accounted for I still have a return.

Will I owe any penalty for underpaying before the deductions are accounted for?

Please let me know what my consequences are for both senarios.

I want to clarify Senario 1. I mean that if I am fully paid for tax year 2006 but when I am filing for 2007 it shows I underpaid for 2007 not 2006. Again 2006 is fully paid. I'm just speaking of 2007 is underpaid. I heard if you are fully paid for the prevoius year then it doesn't matter if you underpaid for the current year when you file.

Answer 1

First scenario, if you didn't pay in for 2007 as much as your 2006 tax liability was, then yes there would be a penalty.

2nd scenario, no, no penalty.

Answer 2

If you will end up with a refund for 2007 after filling out your entire tax return, including any deductions and exemptions, then you did NOT underpay, so no there is no penalty. (scenario 2)

If you ended up owing $2000 after your return was completed (scenario 1), then it's likely you would owe a penalty. Normally there's an underpayment penalty if you owe over $1000, although there are some exceptions that can decrease or eliminate the penalty. One of the exceptions is if the amount you had withheld (plus any estimated payments you made through the year) is equal to or greater than your total tax liability for the previous year, then you don't owe a penalty. Another exception is if the amount you had withheld, plus any estimated payments (in this case for 2007), equals at least 90% of your tax liability for that year.

Whoever told you that if your taxes were paid in full the previous year, you wouldn't owe a penalty for the following year even if you didn't have enough withheld, was WRONG.

Answer 3

OK, lets get some terminology straight, first. You don't file 'for' a return. You file a tax return. A return is the pieces of paper you mail to the IRS (or file electronically) that lists your income, exemptions, deductions, etc.

You may or may not get a "refund" based upon the information in your tax return. But you'll NEVER get a "return" from the IRS.

1. You may or may not have a penalty to pay. Although your debt exceeds $1,000, there are 2 other safe harbor exceptions. If you paid in 90% of your liability there would be no penalty OR if you paid in 100% of the PRIOR years liability there would be no penalty. If you meet any one of the three safe harbor tests -- $1,000, 90% or 100%, there is no penalty.

2. No penalty as you were NOT underpaid. The liability for taxes is when the income is earned and the entitlements for deductions accrue the same way. Therefore there was no underpayment.