What is Underwithholding?

Underwithholding is a situation in which an individual or business does not have enough income tax withheld during the course of the year. This will lead to owing a substantial amount of income taxes when filing the return for the calendar year, which may create a significant financial burden. In addition, underwithholding may also lead to the incurring of penalties from state and national tax revenue agencies that will have to be paid along with the amount of taxes due.

When filing taxes, it is usually a good idea to engage in what is known as overwithholding. This approach creates a situation where more funds than necessary are collected for tax purposes. When the tax return for the calendar year is prepared, the end result is that the total tax burden is not only settled, but also exceeded. At this juncture, the entity that received the collected tax revenue is responsible for issuing a refund of all monies collected above and beyond the actual rate of tax.

Generally, it is easy to avoid underwithholding. Employees can instruct employers to withhold not only the standard amount that is normally deducted from salary and wages, but also withhold a specified additional amount. This approach will ensure there is no large tax debt to deal with later, and will usually result in at least a modest tax refund.

At the same time, self-employed people can use current tax guidelines to calculate taxes on income and also choose to include a little extra with each monthly or quarterly payment made during the course of the year. This activity will also result in no tax debt or penalties to deal with, and may also yield a refund. The self-employed person may wish to employ this approach with both income taxes and self-employment taxes, depending on the current tax regulations that are relevant to the jurisdiction.

In some cases, the penalties and interest that result from underwithholding can be almost as crippling as the outstanding tax obligation. If at all possible, taxpayers should make adjustments in their withholding in order to avoid a situation of underwithholding.