It’s Not “No Big Deal” to Skip Making Quarterly Estimated Tax Payments Anymore.

In 2023, the IRS assessed $7 billion in estimated tax penalties, almost four times more than the amount in 2022. 

IRS penalties for not paying enough in estimated tax payments have become huge.

What used to be a penalty of about $150 in 2022 has jumped to an average of $500 in 2023. The number of taxpayers that got stuck with under payment penalties increased by 2 million year over year. 

What’s going on here? 

The increase is largely due to a steep rise in the interest rate charged by the IRS.

The rate was 3% in 2022, increased to 6% in early 2023 and ended up pat 8% in late 2023.

Here’s the takeaway: It’s not “no big deal” to skip making quarterly estimated tax payments anymore.

What are Federal Income Tax Under Withholding Penalties?

If you don’t pay enough income tax throughout the year, you’ll owe a penalty for not paying enough estimated payments. The penalty is the interest accrued on the amount of underpayment.

But what’s enough?

You have to pay 90% of your end of year tax liability before filing your return if you want to avoid being penalized.

If you work a regular job and receive a paycheck, the deadline for hitting the 90% mark is December 31. Alternatively, the deadline is the January 15 preceding the April 15 deadline if you receive income which is not subject to withholding. This, for the most part, is all forms of income outside of income you've received via paycheck by way of a W-2 employee job.

If you don’t pay a minimum 90 percent, and are not protected by a “safe harbor” rule which I discuss further below, you get hit with the underpayment penalty based on the interest charged on the underpayment amount, interest which has increased from around 3% to 8% year over year.  

A 5% increase makes a huge difference.

***Beware the “Safe Harbor” Rules, e.g. Read the Fine Print

Many taxpayers rely on the “safe harbor” rules, guaranteeing that they won’t be penalized for underpayment.

Here are the rules:

If your adjusted gross income from last year was less than $150k and you pay the IRS 100% of what you owed last year, you won’t be penalized for under paying. 

Alternatively, if your adjusted gross income was more than $150k, you're required to pay 110% of what you owed last year to be protected against under payment penalties. 

But here's the kicker:

It's why so many people get themselves into trouble.

The “safe harbor” rules do not apply on a yearly basis.

They apply quarterly.

Meaning you must meet the safe harbor percentage payment for each individual quarter.

Think about that for a second.

If you have a big second quarter and you don’t pay the “safe harbor” percentage for the second quarter (equal to 100 or 110 percent of the tax owed for last year’s second quarter) until the third or fourth quarter, you’ll be hit with a big underpayment penalty on substantial income.

Make sure you understand this.

Many people do not.

Finally, don’t forget about under payment penalties from the state. States that have an income tax also have penalties on underpayments of estimated income taxes!

To summarize:

1. Penalties for underpayment of estimated taxes have increased significantly due to an increase in interest charged by the IRS which rose from 3% in 2022 to 8% in 2023. Not a small increase. 

2. You must pay 90 percent of your tax liability before filing your return to not be charged with an under payment penalty.

3. Many taxpayers rely on “safe harbor” rules, guaranteeing that you won’t be penalized for underpaying but it doesn't work if you don't understand the rules and implement them. The fine print on the “safe harbor” rules is that they do not apply on a yearly basis. You must meet the “safe harbor” amount separately for each and every quarter. 

4. Don’t forget states also have penalties for estimated tax underpayment.

As always, your support is sincerely appreciated. 

Thanks for reading.

PS: Have you been penalized for underpaying estimated payments?

Do you know why?

What were the circumstances?

Let me know in the comments so we can discuss!