The IRS reminded taxpayers who were assessed an estimated tax penalty for tax year 2016 that they still have time to take steps to reduce or eliminate the penalty for 2017 and future years. To help raise awareness about the growing number of estimated tax penalties, the IRS has launched a new “Pay as You Go, So You Don’t Owe” web page. The IRS.gov page has tips and resources designed to help taxpayers, including those involved in the sharing economy, better understand tax withholding, making estimated tax payments and avoiding an unexpected penalty.
The IRS has seen the number of taxpayers who were assessed this penalty increase in recent years. The number jumped about 40% from 7.2 million in 2010 to 10 million in 2015, when the average penalty reached $130. Most of those affected taxpayers can easily reduce or, in some cases, eliminate the penalty by increasing their withholding or adjusting estimated tax payments for the rest of the year. With a little planning, taxpayers can avoid the penalty altogether. By law, the estimated tax penalty usually applies when a taxpayer pays too little of their total tax during the year. The penalty is calculated based on the interest rate determined by the IRS on unpaid tax.
How to Avoid the Penalty
For most people, avoiding the penalty means ensuring that at least 90% of their total tax liability is paid in during the year, either through income tax withholding or by making quarterly estimated tax payments. Keep in mind exceptions to the penalty and special rules apply to some groups of taxpayers, such as farmers, fishermen, casualty and disaster victims, those who recently became disabled, recent retirees, those who base their payments on last year’s tax and those who receive income unevenly during the year.
Taxpayers may want to consider increasing their tax withholding in 2017, especially if they had a large balance due when they filed their 2016 return earlier this year. Employees can do this by filling out a new Form W-4 and giving it to their employer. Similarly, recipients of pensions and annuities can make this change by filling out Form W-4P and giving it to their payer. In either case, taxpayers can typically increase their withholding by claiming fewer allowances on their withholding forms. If that is not enough, they can also ask employers or payers to withhold an additional flat dollar amount each pay period. Taxpayers who receive Social Security benefits, unemployment compensation and certain other government payments can also choose to have federal tax taken out by filling out Form W-4V and giving it to their payer; however, some restrictions may apply.
For taxpayers whose income is normally not subject to withholding, starting or increasing withholding is not an option. Instead, they can avoid the estimated tax penalty by making quarterly estimated tax payments to the IRS. In general, this includes investment income, such as interest, dividends, rents, royalties and capital gains, alimony and self-employment income. Those involved in the sharing economy may also need to make these payments.
Tips to Make Estimated Tax Payments
Estimated tax payments are normally due on April 15, June 15, and September 15 of the current year and January 15 of the following year. Any time one of these deadlines falls on a weekend or holiday, taxpayers have until the next business day to make the payment. Therefore, the next estimated tax payment for the fourth quarter of 2017 is due Tuesday, January 16, 2018.
The fastest and easiest way to make estimated tax payments is to do so electronically using IRS Direct Pay or the Treasury Department’s Electronic Federal Tax Payment System (EFTPS). For information on other payment options, visit the following link: https://www.irs.gov/payments.
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