In a significant blow to gig economy workers and consultants, the Internal Revenue Service (IRS) has dramatically increased the penalties for tax underpayments. The updated regulations, which took effect on October 1, have seen the IRS raise the interest rate on estimated tax underpayments from 3 percent to a staggering 8 percent over the past two years.
The brunt of these penalties will be borne by pay-as-you-go workers who are not subject to tax withholding and fail to make quarterly estimated payments before the April filing deadline. However, even workers who have taxes withheld could still face a higher penalty if they miscalculate and fail to pay taxes on additional income. This also applies to individuals who receive unexpected dividend payments.
The consequences of these penalties can be severe, with taxpayers potentially having to pay substantial amounts to settle their debts with the IRS. Karla Dennis, an enrolled agent from La Palma, California, warns that changing withholding to increase weekly cash flow can lead to further complications. She advises individuals to establish payment plans and set up budgets to avoid falling into this predicament in the future.
The decision to increase the penalties was prompted by the IRS’s collection of $1.8 billion from approximately 12.2 million Americans in underpayment penalties in the fiscal year 2022. To avoid these fines, taxpayers must settle at least 90 percent of their tax bill before filing or ensure a difference of less than $1,000 between what they owe and what they have already paid.
Alternatively, individuals who pay 100 percent of the previous year’s tax bill will also be exempt from penalties. However, this percentage increases to 110% for individuals earning over $150,000 or married taxpayers filing separately with an income of at least $75,000, as the year ends.
A certified public accountant and financial planner at Mezzasalma CPAs in Tinton Falls, New Jersey, Joseph Doerrer, suggests that individuals evaluate their tax situation. He underscores the importance of ensuring one’s payments align with expectations to avoid unpleasant surprises.
The cautionary tale of a marketing executive from Warren, New Jersey, Sameet Durg, serves as a reminder. Durg incurred a four-figure underpayment penalty and a significant tax bill due to his failure to make estimated payments. Since then, he has learned from this experience and now actively monitors his tax situation throughout the year to prevent a recurrence of such a situation.
The increase in tax underpayment penalties poses a financial risk to gig economy workers and consultants. It serves as a reminder to all taxpayers to stay vigilant and proactive in managing their tax obligations. Taxpayers must stay informed and make timely payments, individuals can avoid the burden of hefty fines and ensure a smoother tax process.