Are you self-employed?
This includes freelancers and business owners.
Estimated Tax Penalty
If you've never been self-employed, or you're new to freelancing or working as an independent contractor, it might be news to you that income taxes (and some others) in the US are actually not all paid at the end of the year. If you've always been an employee of a company, receiving a W-2 at the end of the year, you've had your income taxes, Social Security Taxes and Medicare taxes deducted automatically from your paychecks. What you don't know is that every quarter, your employer pays quarterly taxes to the IRS.
As a freelancer, you are your own employer, so you need to worry about paying your own taxes by the IRS 2022 estimated tax dates. But you also need to estimate what you owe based on your previous earnings. For this, you can use the IRS Form 1040-ES.
Key Takeaways:
- Missing a payment or deadline for IRS estimated taxes leads to penalties.
- The interest you owe on the unpaid amount adds up daily.
- You also rack up IRS underpayment penalties for underpaying your annual taxes.
- A tax penalty calculator can tell you how much you owe and help you calculate the IRS late penalty payment.
What happens when you miss a deadline or a payment?
Missing an estimated tax payment or paying late can lead to estimated tax penalties in the form of fines and interest charges. Even if you are owed a refund when you file your annual tax return, the IRS can still charge you these fees.
How much is the underpayment penalty?
These penalty amounts can add up fast for IRS estimated taxes because of interest on unpaid taxes. If you were making deliveries for Grubhub and Postmates for the last two years, for example, but this year you forgot to make your second quarterly tax payment by the April 18 deadline, you would have to pay a penalty.
If you were to use an estimated tax calculator to figure out that you owed $600 by April 18, you could use an IRS interest and penalty calculator to find out what you owe with the penalty. Interest is .5% of that original amount for each month you don't pay in full, so you'll owe $603 until May 18 when the interest will be compounded again. An IRS Form 2210 can also help you figure out how much you owe.
How much is the penalty for not paying IRS estimated taxes?
There’s a thought looming in every taxpayer’s mind: what is the penalty for underpayment of estimated tax? Well, the IRS can slap you with an underpayment penalty if you pay on time, but you fail to make the full estimated tax payments. This doesn't apply to you if you owe less than $1,000 in tax after withholdings and credits. Two ways to know if you have paid enough in estimated taxes are if you have paid at least 90% of the tax you will end up owing by the end of the current year, or you have paid 100% of the tax shown on last year's annual tax return.
IRS Form 2210
This form is essentially a simple worksheet that helps you calculate the IRS penalty amount by hand. You'll need to complete and include it with your tax return at the end of the year. Form 2210 instructions can be found on the IRS website, along with other information about paying estimated taxes, including the IRS 2022 estimated tax dates.
Best ways to avoid the IRS underpayment penalty
- If you expect to earn about the same amount as last year, you can take the amount of tax paid on your 2021 return and divide it by four to figure out your payment for each quarter. If you do this, but you end up earning more in 2022 than you did in 2021 (or end up with a bigger tax bill), you’re going to be required to pay additional taxes but only when you file your annual tax return, and you won’t have to pay a late tax penalty.
- Say you paid $8,000 in taxes last year. You could pay $2,000 each quarter to make sure you don't underpay on your quarterly taxes. But, if your income drops significantly during the year, you can make quarterly payments equal to 90% of your current year’s tax bill. 90% of $8,000 is $7,200, and divided by four that's $1,800 you should pay each quarter.
- If all this sounds complicated, you can just use FlyFin's quarterly tax calculator. It's based on your income, profession and expenses, and it's powered by A.I. and backed by CPAs, so you pay an accurate tax amount and not a penny more. The entire process takes less than 5 minutes.
IRS calculation for the penalty
Underpayment penalties are calculated by the IRS based on:
- The total underpayment amount
- The period when the underpayment was underpaid
- The interest rate for underpayments
What happens, for example, if your income tax obligation for the previous tax year was $4,000, but you knew you were making more than last year, so this year you paid $4,500. It turns out you made even more than you expected, and your income tax obligation ends up being $6,000. Since you withheld more than the prior tax year’s income tax obligation, you won't have to pay underpayment penalties (yaay!). But, if you made estimated tax payments that were less than your previous year’s income tax, you will have to pay an underpayment penalty. Here's where you can use the underpayment penalty calculator to figure out your penalty for not paying estimated taxes.
Failure to Pay Penalty
This estimated tax penalty is charged when you fail to pay your taxes by the due date.
- The IRS late filing penalty is set to 0.5% of the tax owed and up to 25% for each month the tax remains unpaid.
- After 10 days, the IRS will issue a final notice of intent to seize property, and the 0.5% rate for the late filing penalty increases to 1% per month.
- The IRS penalty rate can be decreased to 0.25% for each month if an installment agreement with the IRS goes into effect.
- You can avoid the IRS penalty if you provide valid reasons for failing to pay on time. To figure out whether or not you owe a penalty for underpayment of estimated tax, use an IRS late payment penalty calculator
Failure to file penalty
You can be charged with this penalty if you file the returns after the due date without a reasonable cause. Both the failure-to-file and failure-to-pay penalties are incurred after the due date of your tax return, while the late payment penalty IRS fee for quarterly estimated tax payments is incurred throughout the year.
If both a failure-to-file and a failure-to-pay penalty are applicable in the same month, the combined penalty for underpayment of estimated tax is 5% (4.5% late filing and 0.5% late payment) for each month that your return was late, up to 25%.
If more than 60 days have passed and you have not filed, the minimum penalty is either $435 (for tax returns with a due date after December 31, 2019) or 100% of the tax required to be shown on the return, whichever is smaller.
Exceptions to the Penalty
- Your estimated quarterly payments were accurate and paid on time
- You generated a large sum of your income later in the year, for example from selling a stock or investment
- A large part of your tax payments occurred earlier in the year, for example if you applied a large overpayment from last year’s return to this year’s taxes
- You changed your filing status to or from married filing jointly
- You filed a joint return last year
- Your 2022 filing status isn’t married filing jointly
To figure out your penalty amount, you can rely on FlyFin’s IRS penalty calculator to help determine how much you owe Uncle Sam. To use the IRS interest and penalty calculator, you'll need to provide:
- Your filing status (single, married filing jointly, married filing separately, head of household)
- Your income details (taxes paid in the previous year and your current income)
- Deduction method: standard or itemized
- Quarterly taxes paid in each quarter
How can I save on taxes?
Even if you end up paying a tax penalty, there are other ways you can save money. Tax deductions can help lower your tax liability and reduce the overall amount of taxes you’ll owe. There are two ways to take deductions: the standard deduction or itemized deductions.
If you work from home and consider it your primary workplace, you can take advantage of deductions, including the home office deduction, the internet and phone deduction, the home office expense deduction or even the rent tax deduction. Tax deductions are a great way to save on taxes.