A Look at Everything About Estimated Tax Payments and Underpayment Penalties!

If you are an experienced taxpayer, you must have heard about the estimated tax penalty the IRS charges from businesses and individuals for underpaying the tax every quarter. It’s a non-deductible interest rate that increases your net cost. Currently, the rate is running at a 17-year higher rate of 8%. It can be a source of stress and confusion for self-employed individuals, who must determine whether they are withholding an adequate amount. Consider earnings from rents, royalties, dividends, retirement plans, capital gains, etc. Even C-corporations are not immune from it if they underpay their taxes.

Managing tax underpayment penalties can be complex, but there are solutions. Professional services, such as those offered by Hogan CPA Financial Services, can guide tax filing, savings optimization, and meeting all criteria on time. Their expertise can help you calculate the correct amount to avoid underpayment penalties, providing relief and peace of mind.

Tax Underpayment Penalty

The IRS imposes tax underpayment penalties on taxpayers for failing to pay a year’s expected income tax through estimated tax payments or withholding. Suppose you are an independent contractor who calculated your yearly income to be less. That will affect your estimated tax payment for the quarter, too. Likewise, an employee can also be penalized if he doesn’t account for the considerable pay raise of the year during his tax withholdings. All these events cause tax liability. A person or business specifically faces this situation if they pay less than 90% of the total tax amount of the current year or 100% of the last year. Anyone with a high income can expect this to be 110% of the previous year’s tax.

The penalty is levied based on the total underpaid amount for the estimated tax due and the IRS-led interest amount charged on the payment one still owes. In the first quarter of 2024, the interest rate for individuals was 8%, and for corporations, it was 7%. 

Averting Underpayment Penalties 

Reducing underpayment penalty risk is crucial, and one can ensure this through different strategies based on specific financial conditions. It’s important to understand that tax should be paid on income earned from investment or self-employment every quarter. Such consistent payments across the year can significantly avoid the risk of facing any unexpected colossal tax bill and, thereby, the ensuing financial burden. Taking control of your tax management by adjusting the W-4 form with the employer to increase the tax withholding or adjusting your estimated tax payment accordingly if you obtain varying income amounts throughout the year can help avert underpayment penalties. It empowers you to take control of your financial responsibilities. 

Suppose you earn USD$ 150,000 or less. The withholding should equal 90% of the estimated tax return for the year or 100% of the last year. Do you make more than USD$ 150,000? In that case, estimated tax payment and withholding should cover a minimum of 90% of the tax you owe in the current year or 110% of the prior year. 

Keeping track of all this and ensuring you pay a fair tax amount every quarter or year is a lot of work. Sometimes, the process can feel cumbersome, too. However, a certified accountant can relieve this tension if you hire their professional services.