According to a 2024 U.S. Census report, about 6% to 11% of the population is self-employed. If you are among the millions who are — whether you’re a part-time gig worker, a full-time freelancer or a small business owner — you need to pay estimated taxes on a quarterly basis.
It’s now more important than ever to pay in full and on schedule. If you don’t, a larger than expected bill may be headed your way. In 2024 the underpayment penalty rate grew to 8%; the highest rate since 2007.
All those penalties add up.
You don’t want to pay more than is required, so learn how to avoid the fees — this year and in the future.
Surging Underpayment Penalty Rate
Self-employed individuals who don’t make on-time and accurate estimated income tax payments face an underpayment penalty — essentially interest on your unpaid balance.
“Underpayment interest rates vary and may change quarterly,” says Miklos Ringbauer, a CPA based in Los Angeles. “The interest rate is set based on the Federal short-term rate, based on compounding interest. Generally, it is the Federal short-term rate plus 3%.”
Because the Fed raised the federal-funds rate in October 2023, the underpayment penalty rate has surged to a whopping 8% — a substantial hike from 3% in 2022.
When the Penalty Is Imposed
As a self-employed individual you’re responsible for sending estimated income tax to the IRS four times a year. For 2024, tax payments are due on:
— April 15
— June 17
— Sept. 16
— Jan. 15
“Your quarterly tax is based on how much tax you owed in the prior year,” says Romeo Razi, a CPA in Las Vegas.
If you missed any of those dates, the IRS will assess the underpayment penalty. It’s calculated on the amount you underpaid when the estimated taxes were due and the interest rate the IRS applies.
You can avoid the penalty if:
— You paid at least 90% of the tax shown on the return you file in spring 2024 or 100% of the tax shown on the return for the prior year, whichever amount is less.
— Or, if the tax return you file in spring 2025 shows you owe less than $1,000.
Keep in mind that the penalty is calculated on a daily basis, so each day you’re late the amount you will owe increases.
Financial Stress Compounds the Problem
As a self-employed person you have to be especially conscious of cash flow, and not just for immediate needs. When there isn’t enough money coming in to cover taxes as well as expenses, the pressure can build.
[Related:How to Be Master of Your Cash Flow]
A 2024 Truist survey found that many who are running their own businesses are currently strapped for cash, with an average of just 4.26 months of reserves on hand.
Razi says he is seeing a greater number of his clients fall behind on their estimated taxes, which is an alarming trend.
“The only explanation is that more people are cash strapped so are sending in less payments than they normally send,” he says. “Savings are at an all time low, people are making their credit card payments late. And now there’s a surge in underpayment penalties for taxes.”
However, Razi says the IRS isn’t singling people out for the penalty. “It’s computer generated,” he says. “There are just more people not paying on time.”
Additional IRS Interest and Penalties
Unfortunately for financially stressed taxpayers, underpayment of estimated taxes is not the only way for a tax bill to escalate.
There are other punitive fees that can be added to the amount you owe, such as:
— Failure to file. This fee will be assessed if the return is not timely filed by April 15 or if you don’t have a valid extension. Expect it to be 5% of the tax owed for each month, or part of a month that your return is late, up to a maximum of 25% of the tax due.
— Failure to pay. A penalty of 0.5% per month of the tax not paid (up to 25%) will be assessed from the due date of the taxes shown on the return.
— Dishonored check. In the event you write a check to the IRS and it bounces, the penalty is 2% of the check amount, or, if it’s under $1,250, it will be $25, whichever is less.
With the combination of potential penalties, the cost of not keeping up with tax payments can be extreme.
[Read: What Happens if You Don’t Pay Your Debts?]
How to Stop the Surge
The only way to offset an IRS underpayment penalty from being assessed is to send in your quarterly payments on time. Set cash aside for the amount you will have to send and be highly attuned to the quarterly payment dates.
“If you have an accountant, they should be sending you a letter showing you how much your minimum payment is,” Razi says. “It should include that you will be charged a penalty if you don’t pay it.”
If you know you’ll have trouble covering the bill, don’t panic, but do take swift action.
“Pay as soon as you can,” Razi says. “I had a client who couldn’t pay his estimated tax payment because he said money was too tight. So, I asked when he could, and explained it’s better to pay a few days late instead of missing the entire quarter.”
Since the IRS automatically calculates the underpayment penalty on a daily basis, the sooner you pay what you owe the less it will cost you in added fees.
Stay on Top of Your Taxes
“The easiest and most effective way to be on top of quarterly tax payment obligations is to maintain an accounting system to record income and expenses,” Ringbauer says.
“This will ensure that the required quarterly payments calculated are accurate and can be made, and therefore no penalties will be imposed,” he adds.
Good accounting software for small businesses, such as FreshBooks and Xero, can help you become and remain organized.
Working with an accountant may be a more expensive alternative, but is often worth the money if your business is complicated.
“A trusted tax advisor will help with accounting and tax filings including updated quarterly tax payment calculations,” Ringbauer says. “They can help reduce or eliminate penalties.”
As a self-employed individual, remaining in good standing with the IRS will always be to your advantage.
“You don’t want a big tax bill to be an albatross around your neck when tax time comes,” Razi says.
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Beating the IRS: How to Dodge the Surge Penalty originally appeared on usnews.com
