The Internal Revenue Service (IRS) has taken significant steps to address underpayment of taxes by increasing the interest penalty that taxpayers may face during the upcoming tax filing season.
Interest Penalty Increase
Earlier this year, the IRS made a noteworthy adjustment by raising the interest penalty on estimated tax underpayments to 8%. This marks a substantial increase from the 3% penalty imposed two years ago.
The IRS is legally mandated to recalculate the interest rate penalty every quarter. For most taxpayers, excluding corporations, this assessed rate consists of the federal short-term rate plus an additional three percentage points.
Impact on Self-Employed and Independent Contractors
Self-employed individuals and independent contractors, including many gig workers, are at risk of incurring the underpayment penalty if they fail to meet their tax obligations.
Taxpayers may avoid this penalty if their balance due, after accounting for credits and other tax-related information, remains below $1,000.
Quarterly Estimated Tax Payments
Those falling under the purview of the estimated tax payment program must make these payments at least once every quarter if they do not have at least 90% of their taxes withheld during regular pay periods.
For instance, taxpayers in this category must make their estimated payment for the fourth quarter of 2023 by January 16, 2024.
Limited Impact on W-2 Employees
The changes introduced by the IRS are unlikely to affect most taxpayers who are W-2 employees. Such individuals typically have tax payments withheld from each paycheck, often resulting in a tax refund rather than an underpayment penalty.
A Cautionary Tale
Joseph Doerrer, a certified public accountant and financial planner in New Jersey, emphasized the importance of considering tax obligations as the year-end approach. He stated, “It’s a cautionary tale for individuals to consider as we approach year-end. Are you where you should be?”
Impact on Taxpayer
Sameet Durg, a marketing executive, shared his experience of discovering that he owed an underpayment penalty, amounting to thousands of dollars, in addition to a substantial tax bill in April.
This situation arose because he needed to make periodic estimated tax payments on his consulting income. Durg has become more vigilant about managing his taxes to avoid such problems.
IRS Tax-Withholding Estimator Tool
The IRS offers a tax-withholding estimator tool for taxpayers to use as a reference. To utilize this tool, taxpayers must input information from their prior year’s tax return, relevant pay stubs, and details about their taxable income sources.
This tool can help taxpayers better manage their estimated tax payments and reduce the risk of underpayment penalties.