High interest rates may be old news, but they could have an unanticipated effect on future taxes.
Specifically, taxpayer penalties are rising, as shown in the chart below. These penalties arise from underpayment of quarterly income taxes. Non-employees (investors, business owners, or retirees) pay income taxes quarterly, rather than through paycheck withholding. Taxpayers face a penalty if they owe $1,000 or more and have not paid 90% of the total by January 15 – the fourth quarter payment deadline. While the average penalty was $150 in 2022, it surged to $500 in 2023. The number penalized also increased from 12 to 14 million.
Interest rates explain the recent increase in penalty rates. The IRS charges interest on the underpayment of quarterly income taxes, which taxpayers then face at the end of the year. This rate simply adds three points to the short-term Treasury rate of the year in which payments were due. The rate was 3% in 2022 but climbed to 8% in the fourth quarter of 2023. It has since remained at 8%, meaning penalties’ upward trend will likely continue in 2024.
Taxpayers have ways to insulate themselves against penalties. First, IRS Form 2210 specifies which quarter income was earned in, ensuring no penalties arise from a misattribution of quarterly income to income earned evenly throughout the year. Second, withholding from pensions, Social Security, or withdrawals from retirement plans can effectively cancel out previous underpayments.
This year, quarterly taxpayers must remain vigilant to ensure they do not have to pay the rising penalties for underpayment.
Source: Laura Saunders, WSJ
Victoria Freeman is a Collegiate Associate at the Manhattan Institute
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