Why do we need to talk about taxes right now?
I know that taxes are a favorite topic to avoid, but as the saying goes, nothing is certain but death and taxes. Because of that, it is better to be knowledgeable about the subject. Last week, a Wall Street Journal article highlighting a rise in the number of Americans who are underpaying estimated taxes caught my eye. The IRS requires that all Americans whose income is not subject to withholding tax pay estimated taxes quarterly. Today, I want to talk about why our listeners should pay attention to this subject.
Tell us about this rise in underpayment.
According to Internal Revenue Service data, the number of Americans who were fined or penalized for nonpayment or underpayment of estimated taxes jumped by 40% between 2010 and 2015, and in 2015, the total number of filers owing penalties may have exceeded the number filing estimated taxes.
Overall, this could have big ramification for the government revenue. While the fees and penalties for late or underpayment are relatively low, they do highlight the challenges of collecting taxes from these taxpayers, along with the growing amount of revenue they represent. According to the Wall Street Journal article, taxes due at time of filing grew about 60%, to $161 billion from $101 billion between 2010 and 2015.
Who should be paying estimated taxes?
Great question. Anyone who is not subject to withholding tax should be paying estimated taxes. Around 80 percent of Americans – those who are wage earners – are subject to withholding. But the other 20 percent – gig workers, independent contractors, retirees, business owners and investors – are supposed to pay their estimated taxes on a quarterly basis. This is important to point out since retirees fall under the category, as do freelancers, and over the past few years there have been surging numbers of both populations.
Why do these workers have to pay quarterly?
As the IRS states on their website, the federal income tax is a pay-as-you-go tax. This provides the government with revenue throughout the year by withholding a portion of a worker’s pay from each pay period. This is done by employers. For those who are not employed by a single employer, who have their own businesses, or are retired, this does not happen. Therefore, the IRS requires these people to pay estimated income taxes four times a year.
Why are we seeing an increase in underpayment?
I think there are several reasons driving this trend. The biggest reason in my mind is that people simply do not know they should be paying estimated taxes. According to the Wall Street Journal article, a 2016 survey found that 69% of self-employed workers in the gig economy did not receive any information from the platform they used – such as Uber or Airbnb.
The same is likely true with retiring boomers. As more baby boomers retire, many are unaware that they must pay income taxes on retirement income or distributions on a quarterly basis. Finally, it has been posited that it has simply been affordable to eat the penalty. After all, between 2010 and 2015, when the number of Americans not paying or underpaying their estimated taxes surged, the interest rate was just 3 percent, so the penalties they paid at the end of the year simply did not represent a big expense.
If we fall into this category of taxpayers, how do we pay and avoid the fines?
To determine if you fall into this category of workers, and how to proceed if you do, visit the IRS website. You can find out about who needs to pay estimated taxes, have a look at the IRS form 1040-es, used for paying estimated taxes, and see the deadlines for each quarterly payment. Remember, you do not want to get on the bad side of the IRS. So, if you are retired, working in the gig economy, or own your own business, take the time to determine if you need to be paying estimated taxes. It will save you money, and perhaps trouble, come April.
Thanks for joining this morning, Mellody.
You are always welcome!
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