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In the U.S., federal income taxes are a pay-as-you-go system. This means the IRS requires you to pay estimated taxes throughout the year—either via withholding from paychecks or by making quarterly estimated payments—as you earn income. Doing so helps you avoid an IRS underpayment penalty. What Is the IRS Underpayment of Estimated Tax Penalty?The IRS Underpayment of Estimated Tax penalty applies if you didn’t withhold enough taxes or didn’t pay enough estimated federal income taxes. Of course, knowing exactly how much tax you’ll owe each year can be challenging, especially if your income, deductions, and available tax credits change from year to year. For that reason, the IRS offers a “safe harbor” method for calculating your estimated payments. The safe harbor method allows you to avoid an underpayment penalty if:
There’s a special rule for high-income taxpayers — meaning those with an adjusted gross income (AGI) of $150,000 or more ($75,000 for married couples filing separately). They need to pay at least 90% of the tax they owe this year or 110% of the tax shown on last year’s return, whichever is smaller. How to Calculate the IRS Underpayment PenaltyCalculating the underpayment penalty is complicated because, unlike other IRS penalties, it’s not a standard percentage or flat dollar amount. Instead, it’s based on:
You can use Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, as well as a worksheet from the Form 2210 Instructions to calculate your penalty. However, if you’re doing the calculation by hand rather than using tax software, be prepared to navigate some pretty complicated instructions and have a calculator ready. It’s not a matter of simply applying a percentage to your underpayment amount. You can also have the IRS calculate the underpayment penalty for you and send you a bill. How to Avoid an Underpayment PenaltyThe easiest way to avoid an underpayment penalty is to ensure you pay at least 100% (or 110% if you qualify as a high-income taxpayer) of last year’s tax. If you owe a penalty with your current tax return and want to avoid the same situation next filing season, you can: 1. Adjust Your WithholdingIf you receive a paycheck from your employer, consider filling out a new Form W-4, Employee’s Withholding Certificate. This form tells your employer how much tax to withhold from your paycheck each pay period. Use the IRS’s Tax Withholding Estimator to help figure out how much federal income tax to have withheld from your paycheck. Give the new Form W-4 to your company’s payroll department—don’t mail it to the IRS. 2. Make Quarterly Estimated PaymentsIf you’re self-employed or have significant income that isn’t subject to withholding, such as interest, dividends, and capital gains, you need to make estimated payments throughout the year. Estimated payments are due on:
If any of those dates fall on a weekend or holiday, the deadline shifts to the following business day. Pay close attention to those deadlines because making your estimated payments late can result in an underpayment penalty, even if you don’t owe any additional tax when you file your return. Look at the total tax on your prior-year return, divide it by four, and pay at least that much on each estimated tax due date to avoid a penalty. 3. Use the Annualized Installment MethodIf you’re self-employed or own a seasonal business, making four equal estimated payments can be difficult. For example, if you own a rafting company in Michigan, you may earn most of your income in the late spring and summer months and close up shop in the winter. In that case, using the annualized income installment method can help you avoid an underpayment penalty. To use this method, complete the Annualized Estimated Tax Worksheet found in IRS Publication 505 at the end of each estimated tax payment period to calculate your required payment. You’ll also need to file Form 2210, including Schedule AI, with your tax return. Read more: How To Reach The IRS With Questions About Your Taxes How to Remove or Reduce an Underpayment PenaltyYou may be able to get the IRS to waive or reduce your underpayment penalty if:
If either of those situations applies, you can call the IRS at the toll-free number shown on your penalty notice, file Form 843 or send a letter to the address shown in the notice explaining your situation. Just keep in mind that the IRS is currently short-staffed and working through a backlog of paper returns and correspondence. It may take a while for you to reach an IRS representative on the phone or get a response to your written request. What happens if you don't pay quarterly taxes?If you don't pay enough tax through withholding and estimated tax payments, you may be charged a penalty. You also may be charged a penalty if your estimated tax payments are late, even if you are due a refund when you file your tax return.
Are quarterly tax payments mandatory?Do you have to pay estimated taxes quarterly? According to the IRS, you don't have to make estimated tax payments if you're a U.S. citizen or resident alien and you had no tax liability for the previous full tax year. And you probably don't have to pay estimated taxes unless you have untaxed income.
What is the underpayment penalty rate for 2022?6% for underpayments. (taxes owed but not fully paid)
What is the late fee for quarterly taxes?The late payment penalty is 0.5% of the tax owed after the due date, for each month or part of a month the tax remains unpaid, up to 25%. You won't have to pay the penalty if you can show reasonable cause for the failure to pay on time.
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