A surging IRS tax penalty is costing Americans billions – here’s how to avoid being hit

A rising tax penalty from the IRS could soon cost some Americans billions of dollars.

Thousands of Americans who pay their income taxes quarterly instead of through withholding from 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 need to take immediate action.

“These charges can hit hard, so getting them right can save people hundreds or even thousands of dollars a year,” says Richard Pon, a CPA in San Francisco. The Wall Street Journal.

Certain groups that may fall into this category include investors, retirees, business owners, gig workers, and others who are not regular employees.

Dual-income households or employees with stock options may also be subject to penalties if their withholdings are insufficient.

In fiscal year 2023, the average estimated tax penalty rose 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 the total number of fines imposed increased from $1.8 billion in 2022 to $7 billion.

Higher interest rates are a major reason for this increase, along with assessments related to the pandemic.

Since World War II, workers have had to pay most of their income tax through payroll deductions or risk fines.

To prevent non-employees from abusing the system, filers with other taxable income – such as from investments or self-employment – ​​must make an estimated tax payment every quarter.

If taxpayers do not pay enough tax throughout the year, they face penalties in the form of interest on their underpaid tax, determined quarterly. In 2021, the IRS rate for underpayments was 3 percent.

This rate, based on the short-term interest rate plus three points, rose to 6 percent in 2022, raising the cost of underpayments set the following year.

By the fourth quarter of 2023, the rate had risen to 8 percent and remains that way, meaning taxpayers continue to be hit with underpayment penalties.

Although underpayment penalties can be complex, it is possible to avoid them by strategically using tax rules, the WSJ reports.

One way to avoid unnecessary fines 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 employees with other taxable income must meet the fourth quarter payment deadline, usually January 15.

But paying the IRS at any time can reduce interest costs, so taxpayers can save by making payments before the April 15 deadline.

One way to avoid unnecessary fines 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 fines.

There are ways to avoid being affected, but with second quarter payments due on June 17, affected taxpayers need to take immediate action

The IRS computers can impose unfair penalties by assuming that income is earned evenly throughout the year.

For example, a Roth IRA conversion in the fourth quarter can result in penalties because the system treats the income as if it were earned throughout the year.

To resolve this, file IRS Form 2210 and Schedule AI, specifying when the income was earned and taxes paid. Check whether your tax software supports these forms.

The IRS also often waives penalties for those who have recently retired at age 62, become disabled, or have reasonable cause. To apply for a waiver, individuals can submit a simplified Form 2210.

Finally, to avoid fines, 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 deadline is eligible.

If your income exceeds $150,000, it is necessary to pay 110 percent of the previous year’s taxes.

But these safe harbors apply quarterly, not annually. This means 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.