Failing to Pay Estimated Taxes Will Cost You More in 2024; IRS Boosts Penalty Interest Charges To 8% (2024)

You’ll pay a higher price for underpaying estimated taxes.

The IRS has raised its penalty interest rate for individuals, to 8% per year. This penalty is assessed for underpayment or late payment of any estimated taxes due throughout the year, typically from people who are self-employed or entrepreneurs.

The IRS charges interest on the amount of tax you have not paid as of the day you file your annual return, and the penalty may apply even if you expect to receive a tax refund.

The interest rate can fluctuate, as the IRS sets it every quarter. The 8% rate went into effect in late 2023 and is the highest since early 2007. Just two years ago, in 2021, the rate was 5%.

For 2022 alone, the IRS collected about $1.8 billion in estimated tax penalties from more than 12 million taxpayers.

Who’s At Risk For Underpayment Penalties?

Failure to keep up with your tax payments or withholding may cause the IRS to assess a penalty for underpayment of estimated taxes. The amount of the penalty is determined by the balance still owed after you’ve filed your annual tax return. The IRS charges its 8% interest rate until the balance is paid in full.

This penalty typically applies to people who work independently, such as contractors, freelancers and gig workers. That’s because self-employed individuals must pay estimated taxes as income is earned or received throughout the year.

Other taxpayers can be affected too.

Those who receive income as interest, dividends, capital gains, prizes, pensions or other financial windfalls may be penalized if they don’t have enough taxes withheld or pay enough estimated taxes on that income throughout the year.

Even if you’re an employee whose federal income taxes are withheld from your salary or wages, you may incur the penalty if your withholding amount is too low.

But individual taxpayers—including sole proprietors, partners and S corporation shareholders—with a small tax liability may get a break.

You May Not Have To Pay Estimated Tax

“There are several reasons why a taxpayer is not required to pay estimated taxes” and will not trigger a penalty, says Alton Bell II, founder of Bell Tax Accountants & Advisors in Chicago.

Generally, the IRS won’t assess an estimated tax penalty if you end up owing less than $1,000 in tax after withholding and refundable tax credits are accounted for.

You also can skip paying estimated tax and avoid the penalty if you meet all three of the following conditions:

• You had no tax liability for the prior year.
• You were a U.S. citizen or resident for the whole year.
• Your last tax year covered a 12-month period.

If you are uncertain about the amount to set aside for estimated taxes, Bell says a good rule of thumb is to reference the IRS’s “safe harbor rule.”

That rule says the IRS won’t assess a penalty if you have paid at least 90% of withholding or estimated taxes for the current year or 100% of the tax shown on the prior year’s tax return, whichever is smaller.

Special rules cover farmers, fishermen and higher-income taxpayers. If you’re in any of those groups, it’s best to speak with a tax professional about estimated taxes you may owe.

How To Stay Clear of Estimated Tax Penalties

Estimating your income as accurately as possible will help you avoid penalties.

The IRS provides forms to help taxpayers figure out the estimated taxes to pay. Form “1040-ES, Estimated Tax for Individuals” shows taxpayers how to calculate their payments using the prior year’s federal income tax as a guide.

Estimated tax payments are typically due quarterly for the prior three months. For example, the first due date was April 15 for the quarter spanning from January 1 to March 31. Subsequent estimated tax payments would be due July 15, October 15, and January 15 of the following year.

The best tax software for the self-employed can help you stay on track.

The IRS May Waive an Underpayment Penalty

If you expect you may owe a penalty for underpayment of estimated taxes, you can request that the IRS waive it.

Typically, the IRS will waive the penalty if you didn’t make the required payment because you experienced a disaster.

The tax agency will also excuse you if you became disabled and can show the underpayment was due to reasonable cause and not willful neglect.