IRS More Than Doubles Tax-Underpayment Penalty
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What is the main topic discussed in this episode?
Listen at schwab.com slash washingtonwise.
Here's your Money Briefing for Thursday, December 7th. I'm J.R. Whelan for The Wall Street Journal.
What new IRS penalty change should taxpayers know about?
For many people, keeping up with their tax payments is made easy by their employer deducting taxes from each paycheck. But others who fall behind on their payments are in for a rude surprise. The IRS has increased the penalty for underpayment of taxes to 8%.
The penalties could actually run in the hundreds or even thousands of dollars. The IRS assessed more than $1.8 billion in these penalties on nearly 12.2 million individual returns in fiscal year 2022. So that's a lot of people.
We'll talk to Wall Street Journal personal finance reporter Ashleya Ebling after the break.
Listen at schwab.com slash washingtonwise.
How much did the underpayment penalty rise and why?
People who underpay their taxes are in line for a much stiffer penalty from the IRS than in previous years. Wall Street Journal personal finance reporter Ashleya Ebling joins me. So Ashleya, how much is the IRS raising this penalty?
It can change quarterly. As of October 1st, the IRS is charging 8% interest on estimated tax underpayments. That's up from 3% two years ago.
Who is most at risk of facing the 8% underpayment penalty?
That's a big jump.
It is. It's one of the many effects of rising interest rates. Why it's happening is it's statutory.
How is the 8% penalty calculated and applied over time?
It's tied to the federal short-term rates.
Who's likely to be most affected by this?
So it's most important for gig workers and consultants, people who don't have taxes withheld and figure they can pay their taxes come April. People who get steady paychecks with tax withholding could also be affected if they have additional income and get the math wrong.
So just to make sure we understand the numbers, the penalty is 8% of what?
It's 8% of the taxes that you've underwithheld. And it's not a flat, oh, I owe $10,000 and it's $800 because it's calculated on a daily basis. And it's a blended rate for the year. But the bad news is it's gone up to 8 percent this quarter. So the good news is if you pay in now, it's possible that you could reduce the penalty or it would even be eliminated.
So this penalty is risen as interest rates have risen. If interest rates fall, as they could do next year, could this penalty fall?
Yes, that's exactly what would happen.
I want to get to the math inner workings of this in a moment, but what kind of an impact will these penalties have on people?
The penalties could actually run in the hundreds or even thousands of dollars.
What common mistakes lead to underpayment penalties?
The IRS assessed more than $1.8 billion in these penalties on nearly 12.2 million individual returns in fiscal year 2022. So that's a lot of people. So beyond the underpayment penalties, things can get even worse. Total tax bills basically increase the risk that you might not be able to pay your full balance in April. And then failing to pay the full balance can lead to more penalties and worst case scenario, liens and levies.
Where do people tend to make a mistake that results in them underpaying and then as a result facing this type of penalty?
For most taxpayers, the employer withholds taxes in every paycheck, but staying on top of estimates is important for people with fluctuating or self-employment income.
What steps and tools can people use to avoid estimated-tax penalties?
There's other scenarios that can take place for taxpayers who get bonuses and equity compensation when the withholding is too low. And even people with higher than usual interest from high-yield savings accounts could be affected. Probably the most common scenario is when wage earners who are used to having tax withholding by an employer start a business, they might not know that they're subject to the quarterly estimated tax payments.
So in their case, enlisting a tax professional might be helpful?
It is. The IRS has really good explanations of how to pay in quarterly estimated tax payments, too.
What can people do to avoid underpayment penalties?
You have to make sure your withholding or your estimated payments are up to a certain level. And for most people, the rule is they must pay a 90 percent of their taxes through withholding during the calendar year to be called like a safe harbor.
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Chapters
8 chapters
1
What is the main topic discussed in this episode?
0:01–0:37
2
What new IRS penalty change should taxpayers know about?
0:37–1:51
3
How much did the underpayment penalty rise and why?
1:51–2:13
4
Who is most at risk of facing the 8% underpayment penalty?
2:13–2:20
5
How is the 8% penalty calculated and applied over time?
2:20–3:28
6
What common mistakes lead to underpayment penalties?
3:28–4:13
7
What steps and tools can people use to avoid estimated-tax penalties?
4:13–5:54
8
When can the IRS waive underpayment penalties and what should you do if hit?
5:54–7:44
Speakers
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