Tax season is rarely met with smiles, but this year, it brings a particularly stern warning: the Internal Revenue Service (IRS) has increased its interest rate on estimated tax underpayments to 8%, a significant leap from the 3% rate just two years ago. This hike, influenced by overall rising interest rates, could mean a costly surprise for many come next spring.
This change predominantly impacts gig workers, consultants, and those with side incomes who usually wait until April to settle their tax bills. Even regular employees could find themselves in hot water if their additional income isn’t accurately accounted for.
In the 2022 fiscal year, the IRS imposed over $1.8 billion in penalties for underpaid estimated taxes on nearly 12.2 million individual returns. These penalties can range from hundreds to thousands of dollars, underscoring the importance of accurate tax payments throughout the year.
The Risks of Underpayment
Apart from the obvious financial burden of penalties, underpaying taxes can lead to even greater troubles. If taxpayers are unable to settle their full balance in April, they might face further penalties and, in extreme cases, IRS collection actions, including liens and levies.
Bryan Bennett, a CPA and certified valuation analyst, emphasizes the importance of year-end tax assessments. “Are you where you should be?” he asks, urging individuals to reflect on their tax status as the year closes.
Understanding the Pay-As-You-Go System
The U.S. tax system operates on a pay-as-you-go basis. This means that taxes should be paid as income is earned, either through withholding or by making estimated tax payments throughout the year. To avoid penalties, most filers must pay 90% of their taxes during the calendar year, either through withholding or estimated quarterly payments.
The deadline for the fourth quarter of 2023’s payment is January 16, 2024. No underpayment penalty is charged if the due balance is less than $1,000 after withholding and credits are considered.
Strategies to Stay on Track
- Avoid Underpayment Penalties: For example, a gig worker who owes $10,000 in taxes but didn’t make quarterly estimated payments could face a $512 penalty. To prevent this, pay at least 90% of the current-year tax bill or 100% (110% for higher earners) of the previous year’s bill.
- Use the IRS Tax-Withholding Estimator: This tool helps calculate the correct amount to withhold, taking into account various income sources.
- Adjust Your Withholding: If necessary, revise your Form W-4 to increase withholding, especially if you have non-wage income sources.
- Make Estimated Payments: If additional withholding isn’t feasible, make estimated tax payments. The sooner, the better, as the penalty involves a daily calculation.
- Request a Penalty Waiver: In certain circumstances, such as retirement or disability, the IRS may waive estimated tax penalties.
It’s crucial for taxpayers, especially those with variable or self-employed incomes, to stay vigilant about their tax obligations. The first step is awareness, followed by proactive measures to ensure compliance. As always, consulting with a professional, like the team at Bennett, Bennett & Trice, can provide personalized guidance and help navigate the complexities of tax planning and payments.
For further inquiries or assistance, don’t hesitate to contact us.
**Disclaimer**: This article is for informational purposes only and does not constitute legal, tax, or financial advice. Please consult with a professional for specific advice.