Accredited Wealth Management Advisor Practice Exam

What can individuals do to mitigate the impact of underpayment penalties?

1. Only estimate taxes in April.

2. Consult tax advisers regularly.

3. Increase withholding to cover underpayments.

4. Ignore penalties due to financial hardship.

The correct answer is: Increase withholding to cover underpayments.

Increasing withholding to cover underpayments is an effective strategy to mitigate the impact of underpayment penalties. When individuals adjust their payroll withholding so that more tax is taken out of their paychecks throughout the year, they effectively reduce their tax liability at the end of the year. This means they can prevent underpayment throughout the year and eliminate or diminish the potential for penalties assessed by the IRS for not meeting the required minimum tax payment thresholds. Taxpayers are generally required to pay either 90% of their current year's tax liability or 100% of the prior year's tax liability (110% for higher earners) to avoid underpayment penalties. By increasing withholding, individuals can ensure that their total tax payments during the year meet these requirements, thus reducing or avoiding penalties altogether. Regular consultations with tax advisers can provide additional guidance and strategies but do not directly alter the payment process itself. Estimating taxes solely in April might lead to an incorrect or insufficient payment and does not proactively manage the issue throughout the tax year. Ignoring penalties due to financial hardship does not resolve the obligation and could lead to increasing penalties and interest, making the situation worse over time.