As of October 1, 2023, the IRS has raised the estimated tax underpayment penalty to 8%, a significant increase from the 3% of two years ago. The decision was partly due to rising interest rates, but these higher penalties will impact those who do not automatically withhold their taxes, such as gig workers and consultants or those with additional income.
The underpayment penalty kicks in if filers pay less than 90% of their owed taxes in a calendar year or fail to make the quarterly estimated payments. Partner Chris Oliva recommended individual taxpayers protect themselves by paying, in a calendar year, either 90% of the current year's tax bill or 100% of the previous year's. Those with an adjusted gross income in excess of $150,000--or $75,000 if married and filing separately--would need to meet a 110% threshold of their prior year's taxes to avoid the penalty. The penalty can be calculated on Form 2210, referencing a blended interest rate that can mean an unpleasant surprise at the end of the year. According to Oliva, "A gig worker who owes $10,000 in taxes and didn’t make quarterly estimated payments of $2,500 would face a $512 underpayment penalty, along with his tax bill on April 15."
Another recourse for those withholding too little is to put aside additional withholding by filing out a revised Form W-4 with your employer, Oliva said. If you are taking required minimum distributions, you can also choose a higher withholding amount. Extra withholding amounts, regardless of the time frame, are considered by the IRS to have been spread evenly throughout the year and can lessen or eliminate your penalty.
If this is not an option, make sure to pay in estimates. "If additional withholding isn’t an option, make an estimated tax payment. The sooner you do it, the better, because the underpayment penalty amount involves a daily calculation," said Oliva. "For the gig worker with $10,000 in taxes due, if he or she paid on Jan. 16 instead of April 15, the penalty would be $317, down from $512." Meeting the estimates can be as simple as electronically paying through the IRS Direct Pay or setting up a account with the Treasury's Electronic Federal Tax Payment System.
In addition, you can use the IRS tax withholding calculator to ensure you're meeting your quarterly or annual obligations and potentially request a penalty waiver, if you meet the criteria noted on Form 2210.
Read the full article published by the Wall Street Journal.
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