If you haven’t been sending part of your income to the IRS in recent months, this week is the last chance to avoid a tax penalty.
The deadline for third-quarter estimated taxes is Sept. 15, applying to income from self-employment, small businesses, investments, gig economy work and more, according to the agency.
“It’s a pay-as-you-go system,” said certified financial planner John Loyd, owner at The Wealth Planner in Fort Worth, Texas. “A lot of folks don’t find out until they file their tax return and they get a very nasty surprise.”
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While many workers withhold taxes from each paycheck, others must make payments four times per year. The late-payment penalty is 0.5% of your balance due, for each month after the deadline, up to 25%.
You can make quarterly estimated tax payments through IRS Direct Pay, send money through your IRS online account or another option listed on the IRS payments website. But experts urge taxpayers to pay online.
“I would much rather pay electronically and have a record of it,” said JoAnn May, a CFP and CPA who founded Forest Asset Management in Berwyn, Illinois. She noted some filers may also have state-level estimated tax payments due.
Other scenarios requiring estimated tax payments may be selling investments, earning a bonus or making retirement account withdrawals without withholdings, Loyd said.
How to avoid federal tax penalties
You can avoid federal penalties by paying, over the course of the year, the lesser of 90% of your 2022 taxes or 100% of your 2021 bill if your adjusted gross income is $150,000 or less. (You’ll need 110% of your 2021 bill if you earn more than $150,000.)
“As long as you pay that amount into the system, your income could quadruple and it does not matter,” Loyd said. “You won’t have an estimated tax penalty.”
Of course, you’ll still need to set aside enough money to cover total levies for the year when you file taxes in April, he said.
Why some don’t make quarterly estimated tax payments
While estimated payments may help avoid penalties, some filers may purposely skip them, despite the late fee, experts say.
“The word penalty scares people,” said Marianela Collado, a CFP and CPA at Tobias Financial Advisors in Plantation, Florida. “But it’s nothing more than the IRS charging you interest.”
In some cases, the decision to make estimated payments depends on an entrepreneur’s cash flow, she explained, or the ability to earn more by investing the money elsewhere.
However, they still need to save the money for quarterly taxes, along with the penalty, and “not everyone has the discipline,” Collado added.