IRS move could carry hefty cost for some taxpayers

The Internal Revenue Service (IRS) is raising the stakes for those who underpay their taxes by ratcheting up the interest penalty that will be assessed in next spring’s tax filing season.

Earlier this fall, the IRS increased its interest penalty on estimated tax underpayments to 8% – a notable jump from 3% just two years ago. The IRS indicated that the interest rate penalty is determined every quarter and that for taxpayers other than corporations the assessed rate is the federal short-term rate plus three percentage points.

Self-employed workers and independent contractors, including many gig workers, will be at risk of being hit with the underpayment penalty if they fail to pay the amount the IRS believes they owe. Taxpayers don’t face an interest penalty for underpayment if the balance due is under $1,000 after their credits and other tax account information is factored in.

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Such workers are required to make estimated tax payments at least once each quarter if they don’t have at least 90% of their taxes withheld during the regular pay periods. For example, taxpayers subject to this payment program will make the estimated payment for the fourth quarter of 2023 by Jan. 16, 2024.

The changes won’t affect most taxpayers who are W-2 employees and have tax payments withheld from each paycheck they receive. In the majority of those cases, taxpayers are ultimately owed a tax refund rather than facing an underpayment penalty.

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Joseph Doerrer, a CPA and financial planner in New Jersey, told The Wall Street Journal, “It’s a cautionary tale for individuals to think about as we get toward year-end. Are you where you should be?”

Sameet Durg, a marketing executive, was surprised when he went to Doerrer to have his taxes prepared when he learned that he owed an underpayment penalty that reached into the thousands of dollars in addition to a large tax bill in April because he wasn’t periodically making estimated payments on taxes owed from his consulting income.

“Now I pay attention to taxes all year around,” Durg told the Journal. “I don’t want the giant hit in April.”

The IRS has a tax-withholding estimator tool available for taxpayers to reference. To use the tool, taxpayers would need to input information from their prior year’s tax return, as well as relevant pay stubs and taxable income sources.