A charge added by the IRS or a state tax agency when someone does not pay enough tax during the year, usually through quarterly estimated payments or paycheck withholding.

It often catches people who do not have steady W-2 withholding, such as contractors, self-employed workers, people receiving investment income, or anyone who gets a lump-sum payment and assumes they can settle up at tax time. That is the trap: even if the full tax is eventually paid, the government can still assess a penalty for paying too late during the year. The amount usually depends on how much was underpaid and for how long. Michigan can assess a similar penalty for state income tax under the Michigan Income Tax Act of 1967.

For injury claims, this matters because people are often handed money during a chaotic time and given bad advice. Compensation for physical injuries is often not taxable, but some parts of a recovery may be, such as certain interest, investment earnings on settlement funds, or pay that replaces taxable wages. If that creates tax due and no estimated payments are made, an estimated tax penalty can pile onto the bill along with interest.

That can shrink a settlement fast. Before spending money from a claim, it is smart to sort out what is taxable, what is not, and whether quarterly payments are needed to avoid a preventable penalty.