Understanding Estimated Tax Payment Penalties

When you earn or receive income throughout the year, you are taxed on that money. If you receive a paycheck or a pension, tax is typically withheld from those payments by your employer, but when your income is from sources like self-employment, you may have to make estimated tax payments, which are quarterly prepayments based on the amount earned and its estimated tax liability—just like withholding on your paycheck every two weeks.

Who Has to Pay Estimated Tax?

Individual taxpayers generally must make estimated tax payments if they owe tax from a prior year and/or expect to owe at least $1,000 in taxes when they file their return. Corporations make these payments if they expect to owe at least $500 when their return is filed.

In general, you have to make estimated tax payments if your income is from sources like the following:

• Self-employment

• Capital gains

• Dividends

• Financial awards and prizes (like radio prizes or sweepstakes)

Failure to pay the right of amount of taxes may result in penalties that can add up quickly.

How do Estimated Tax Penalties Work?

IRS Notice 433 explains the rate of interest applied to underpaid taxes, estimated or otherwise. It is determined on a quarterly basis, and for all taxpayers except corporations, the underpayment rate is the federal short-term rate plus three percentage points.

 If you miss a filing deadline, it can cost you an additional 5% of the unpaid balance each month, and failing to pay what you owe adds an extra 0.5% on top of that. If you’re unable to resolve the debt immediately, it adds up fast.

Can Estimated Tax Payment Penalties Be Waived?

The IRS may waive your estimated tax payment penalties if any of the following conditions apply to your situation:

• You owe less than $1,000 in tax after accounting for all withholdings and credits .

• You paid at least 90% of the current year’s taxes or all of the taxes owed for the year before, whichever is smaller.

• Your failure to make estimated payments were caused by unusual circumstances beyond your control making a penalty unfair (this is heavily fact-dependent).

• You retired after turning 62 or became disabled during the tax year when you were required to make estimated payments, and the underpayment was not intentional.

Underpaying your taxes leads to significantly growing tax debt, as the IRS will continue to charge you interest until your debt is paid in full. You are allowed to appeal the interest under certain conditions, such as evidence of mathematical errors, but it’s a complicated process that you should only undertake with help from an experienced tax attorney.