A growing IRS tax penalty could soon cost some Americans billions of dollars.
Thousands of Americans who pay their income taxes quarterly instead of withholding their paychecks could face a significant increase in underpayment penalties.
There are ways to avoid being affected, but with second quarter payments due on June 17, affected taxpayers should take immediate action.
“These fees can be very damaging, so getting them right can save people hundreds or even thousands of dollars a year,” said Richard Pon, a certified public accountant in San Francisco. The Wall Street Journal.
Certain groups that may fall into this category include investors, retirees, business owners, self-employed workers, and others who are not regular employees.
Thousands of Americans who pay their income taxes quarterly instead of with withholding from their paychecks could face a significant increase in underpayment penalties.
Couples with two earners or employees with stock options could also be subject to penalties if their withholdings are insufficient.
In tax year 2023, the average estimated tax penalty soared to about $500, up from $150 in 2022, according to the Internal Revenue Service (IRS).
The number of affected tax filers increased from 12 million to 14 million, and total penalties imposed increased to $7 billion from $1.8 billion in 2022.
Higher interest rates are a key reason for this increase, along with pandemic-related recovery assessments.
Employees have been required to pay most of their income taxes through withholding from their paychecks since World War II, or face penalties.
To prevent non-employees from gaming the system, taxpayers with other taxable income, such as from investments or self-employment, must make estimated tax payments quarterly.
If taxpayers do not pay enough taxes throughout the year, they face penalties in the form of interest on the underpayment, which is set quarterly. In 2021, the IRS rate on underpayments was 3 percent.
This rate, based on the short-term Treasury rate plus three points, increased to 6 percent in 2022, raising underpayment charges assessed the following year.
By the fourth quarter of 2023, the rate had risen to 8 percent and remains there, continuing to impact taxpayers with underpayment penalties.
While penalties for underpayments can be complex, they can be avoided by making strategic use of tax rules, the WSJ reported.
One way to avoid unnecessary penalties is to pay early.
Taxpayers who owe $1,000 or more must pay 90 percent of their tax bill by the April 15 due date.
For employees, this deadline is the end of the year, while those with other taxable income must meet the fourth quarter payment deadline, usually January 15.
But paying the IRS at any time can reduce interest charges, so taxpayers can save by making payments before the April 15 deadline.
One way to avoid unnecessary penalties is to pay early.
Taxpayers who owe $1,000 or more must pay 90 percent of their tax bill by the April 15 due date.
Avoiding IRS computer errors is another way to avoid unnecessary penalties.
There are ways to avoid being affected, but with second quarter payments due on June 17, affected taxpayers should take immediate action.
IRS computers can impose unfair penalties by assuming that income is earned evenly throughout the year.
For example, a fourth-quarter Roth IRA conversion could result in penalties because the system treats the income as if it were earned throughout the year.
To fix this problem, file IRS Form 2210 and Schedule AI, specifying when the income was earned and taxes paid. Check if your tax software supports these forms.
The IRS also typically waives penalties for those who recently retired at age 62 or older, became disabled, or can show reasonable cause. To apply for an exemption, individuals can file a simplified Form 2210.
Finally, to avoid penalties, taxpayers should consider the dangers of safe harbors, the WSJ reported.
If adjusted gross income is $150,000 or less, paying 100 percent of the prior year’s tax by the due date qualifies.
If your income exceeds $150,000, you must pay 110 percent of the previous year’s tax.
But these safe harbors apply quarterly, not annually, meaning that if someone has income in the second quarter but doesn’t pay the safe harbor amount until the third or fourth quarter, underpayment penalties may still apply.
