IRS Penalizes Earners for Estimated Tax Filings

More Americans who pay their income taxes each quarter are being penalized by the IRS for making mistakes or missing payments.

There's been a nearly 33% jump — from almost 7.5 million to nearly 10 million — in the number of penalties levied between fiscal years 2007 and 2016, IRS data show.

Retirees, business owners, investors, gig workers, freelancers and others with non-traditional jobs typically get penalized because they're often non-wage earners who don't work for employers that regularly withhold taxes on salary income.

"The data seems to suggest there are more people who either don't understand they need to pay quarterly taxes or are making mistakes," said IRS spokesman Eric Smith.

Although the IRS isn't sure why the number of penalties is rising, some tax experts suggest that the increase may be driven by a workforce shift in which more Americans have informal jobs and lack long-term employment contracts. 

Federal tax law requires many non-wage earners to file estimated tax payment quarterly so they won't be treated differently from the roughly 80% of U.S. taxpayers whose income taxes are deducted from their salaries throughout the work year.

The pay-as-you-earn requirement applies to non-wage earners in certain situations, including those who expect to owe $1,000 or more for a current tax year after subtracting refundable credits. These earners should submit quarterly payments that will cover at least 90% of the estimated tax due on their income in a given year.

Certain exceptions apply to farmers, fishers, casualty and disaster victims, recent retirees, people who are newly disabled, those who base their payments on the prior year's tax and people whose income flowed in unevenly during the year.

Those the IRS feels made mistakes, or underpaid, are now receiving penalty notices for the 2016 tax year. "Prime time is during the summer," said Smith.

The tax agency hasn't mounted a special enforcement effort targeting underpayment of estimated taxes. So why is there a rising number of non-wage earners who make mistakes on estimated taxes and get penalized?

"I think what's driving it is the change in the workforce, change in employment relationships and the increase in informal work arrangements that people are calling the gig economy," said Nathan Rigney, senior tax research analyst with The Tax Institute at H&R Block, a major U.S. tax preparation company.

Rigney cited a Dec. 2016 working paper in which the Federal Reserve Bank of Boston estimated that 37% of nonretired U.S. adults participated in paid informal work arrangements. Additionally, roughly 20% received non-wage income from activities that did not exclusively involve renting their own property or selling their own goods, the paper concluded.

Two other potential factors — more people who owe taxes on large investment gains and retirement income distributions paid to Baby Boomers leaving the workforce in increasing numbers — could play only small roles in the penalty increase, Rigney said.

"We can speculate, but we don't have any (definitive) reasons," said Smith.

However, the IRS has answers for those who either receive penalty notices or want to avoid them in the future.

The tax agency's annualized income installment method of payment has a worksheet to help non-wage earners who received all of their income in the last part of the year and made a fourth-quarter payment to cover it. The method also may reduce the penalty for someone who made no estimated tax payments.

Planning ahead for next year, Smith said most non-wage earners can reduce or eliminate any penalties by increasing their estimated tax payments for the remainder of 2017.

By Kevin McCoy for USA Today

Published: 08/14/2017

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