Underpaying taxes throughout the year results in two problems once tax time comes around:
- Instead of getting a nice tax refund check, you owe the IRS money.
- You may be hit with underpayment penalties.
Many people end up being charged underpayment penalties out of ignorance—they didn’t know how much they were required to pay. The underpayment penalty rules are complicated, particularly if you are self-employed.
Estimated Taxes
Many of those who underpay taxes are self-employed or independent contractors. That’s because instead of having an employer handle tax withholding for them, 1099-workers need to calculate their estimated taxes and submit them to the IRS quarterly.
The 1040-ES calculation could confuse an accountant, much less your average taxpayer. The easiest way to make sure you pay enough in estimated taxes is to understand the safe harbors:
- If you’ll owe less than $1,000 for the entire tax year—including self-employment and federal income taxes—you’ll be safe from underpayment penalties.
- You’ll also receive safe harbor treatment if you pay 100% of the amount you paid in taxes for the previous tax year.
- You can pay at least 90% of the amount you’ll owe for the current tax year in estimated taxes, but this requires knowing ahead of time approximately how much you’ll make during the year.
- You don’t need to pay estimated taxes this year if you had zero tax liability last year or you weren’t required to file a tax return last year, but you must have been a U.S. citizen or resident alien for the entire previous year.
The simplest solution: pay as much in estimated taxes this year as you owed in taxes for all of last year. This rule will work in most cases if your income isn’t going to be dramatically different from last year.
One final note—these safe harbors allow you to avoid underpayment penalties, but you could still end up owing taxes when you file your return, so prepare accordingly.
W-4 and W-4V
Employees who are underpaying taxes can adjust their W-4 forms to claim fewer allowances or choose to have an additional amount withheld from each paycheck. You could also pay estimated taxes, but this requires more work on your part.
If you are receiving Social Security benefits or unemployment compensation, you can request to have taxes withheld using Form W-4V. Not everyone needs to have taxes withheld from their Social Security benefits, but you may need to if you have other sources of income.
If you’ve accumulated back taxes and penalties due to tax underpayments, consult a tax resolution attorney to discuss your tax relief options.
The Gartzman Law Firm offers delinquent tax return preparation and tax settlement help for both federal and state tax debt. Use our contact form to request a consultation with an Atlanta tax resolution attorney.