The Internal Revenue Service (IRS) has just made a significant change that could impact many taxpayers, particularly those who are self-employed or work as independent contractors. Understanding these changes is crucial, especially for retirees who might be managing their finances post-retirement.
The Rise in Interest Penalty for Underpayment
In a notable shift, the IRS has increased the interest penalty on estimated tax underpayments to 8%, a substantial rise from the 3% rate just two years ago. This change is set to take effect in the upcoming tax filing season. The IRS adjusts this rate quarterly, and for non-corporate taxpayers, it’s calculated as the federal short-term rate plus three percentage points.
Who is Affected?
This change predominantly affects self-employed individuals and independent contractors, including many gig workers. These taxpayers risk facing the underpayment penalty if they fail to pay the amount the IRS deems they owe. However, there’s a threshold: if the balance due is under $1,000 after considering credits and other tax account details, the penalty doesn’t apply.
Quarterly Estimated Tax Payments
For those who don’t have taxes withheld during regular pay periods, making estimated tax payments at least once each quarter is essential. Failing to do so could result in penalties. For instance, the estimated payment for the fourth quarter 2024 is due by January 16, 2024. This is particularly important for retirees who have shifted from regular employment to consulting or part-time work.
W-2 Employees: Less Impact
Most W-2 employees, who have taxes withheld from each paycheck are less likely to be affected by this change. These taxpayers are often more likely to receive a tax refund than face an underpayment penalty.
A Real-World Example
Joseph Doerrer, a CPA and financial planner, highlights the importance of being proactive with tax payments. He shares the story of Sameet Durg, a marketing executive who faced a hefty underpayment penalty and a large tax bill in April due to not making periodic estimated tax payments on his consulting income. Durg’s experience is a cautionary tale for all, especially retirees managing diverse income sources.
IRS Tax-Withholding Estimator Tool
To assist taxpayers, the IRS offers a tax-withholding estimator tool. This tool can be beneficial for retirees to estimate their tax liability and avoid any surprises. It requires information from the previous year’s tax return and current pay stubs or income sources.
The Bottom Line
The IRS’s move to increase the interest penalty for underpayment of estimated taxes is a critical development for taxpayers, especially those who are self-employed or working as independent contractors. Retirees, in particular, must be vigilant in managing their tax payments to avoid any unexpected financial burdens. Staying informed and proactive in tax planning is more critical than ever.