As a regular W-2 employee, with few exceptions, you only worry about filing your taxes once per year. But the self-employed, who aren’t getting taxes taken out of a paycheck by an employer, must calculate and pay estimated income taxes every three months.
It’s enough of an aggravation that you may elect not to follow the rules, limit tax calculations to once per year and face underpayment penalties.
Each quarter, the IRS announces the interest rate on underpayment for estimated quarterly taxes. And the interest rate has vaulted from 3% to 8% since Q1 of 2022. So the downside of avoiding quarterly payments for the self-employed has increased dramatically.
"It had been very common that people wouldn't deal with [estimated quarterly taxes] until later," says money expert Clark Howard. "Because interest rates in the economy were so low, the interest rates the IRS charged for a long, long time were so low that people were like, 'OK, I'll just deal with it next year.'
“Those interest rates are not low anymore. Just as we’re paying higher interest rates on car loans, mortgages, credit cards, whatever – the interest rate the IRS charges goes up with prevailing interest rates or it goes down with prevailing interest rates. So right now it’s really, really high tax if you don’t deal with it until next year.”
IRS Underpayment Penalties: Interest Rates and How To Calculate
The IRS publishes new underpayment penalty interest rates each quarter. For example, the interest rate was 8% from April to June. And the IRS announced a few months ago that the interest rate will remain at 8% for Q3 (July to September).
As Clark mentioned, the interest rates on penalties for failing to pay quarterly estimated taxes nearly tripled from Q1 2022 to Q4 2023. Check out this quarter-by-quarter progression since 2019.
| Year | Q1 Interest Rate | Q2 Interest Rate | Q3 Interest Rate | Q4 Interest Rate |
|---|---|---|---|---|
| 2024 | 8% | 8% | 8% | TBD |
| 2023 | 7% | 7% | 7% | 8% |
| 2022 | 3% | 4% | 5% | 6% |
| 2021 | 3% | 3% | 3% | 3% |
| 2020 | 5% | 5% | 3% | 3% |
| 2019 | 6% | 6% | 5% | 5% |
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Estimated Quarterly Tax Due Dates
For 2024, the due dates to submit your quarterly estimated taxes are as follows:
- Q1: April 15, 2024
- Q2: June 17, 2024
- Q3: Sept. 16, 2024
- Q4: Jan. 15, 2025
How To Calculate Your Underpayment Penalties
Calculating penalties for estimated quarterly taxes is challenging but possible.
It’s easier to calculate in retrospect than it is to predict. Because predicting involves projecting the quarterly interest rates and your total taxable income for the year.
The market widely expects the Fed to cut interest rates in September. The Fed raised interest rates 11 times from March 17, 2022, to July 26, 2023, to combat inflation. And the IRS raised interest rates on underpayment penalties from 3 to 8% from 2021 to 2024. There are a lot of variables at play.
But let’s assume an 8% interest rate on underpayment penalties for Q4 of this year as well.
Now let’s say you’re self-employed and you owe $10,000 in quarterly taxes every three months in 2024. But you wait until April 15, 2025 (Tax Day) to pay a single dollar.
You can’t apply 8% interest to $40,000 ($10,000 x 4 quarters) and get your underpayment penalty:
- The $10,000 you owed on April 15, 2024, for Q1 will have accrued a year of interest. The calculation: $10,000 x .08 = $800.
- The $10,000 you owed on June 17, 2024, for Q2 will have accrued about nine months of interest. The calculation: $10,000 x .06 = $600.*
- The $10,000 you will have owed on Sept. 16, 2024, for Q3 will have accrued about six months of interest. The calculation: $10,000 x .04 = $400.*
- The $10,000 you will have owed on Jan. 15, 2025, will have accrued three months of interest. The calculation: $10,000 x .02 = $200.
- $800 + $600 + $400 + $200 = $2,000
*To be technical, you will have accrued interest for two days fewer than nine months (Q2) and one day fewer than six months (Q3). You could take that into account in your calculations.
So, in this scenario — the underpayment penalty interest rate remaining at 8% in Q4 and you owing $40,000 in self-employment taxes ($10,000 per quarter) — you’d pay $2,000 in underpayment penalties.
At 3% interest, you’d only pay $750 in penalties. So you can see what the current penalty interest rate will cost you above what it did as recently as early 2022.
Who Must Pay Quarterly Estimated Taxes?
Almost everyone with taxable income not subject to federal withholding must pay estimated quarterly taxes.
If you work a side hustle, work as a 1099 employee, own your own business or get income another way outside of a regular job, you should pay quarterly estimated taxes.
Because of the slower gear of the economy and a worsening job market, Clark says, the pool of people needing to pay quarterly estimated taxes is getting larger.
“It’s so common now even if you have a regular full-time job that you’re doing something on the side. It’s also very possible that someone is doing just a series of side jobs,” Clark says.
“There are so many of us doing what’s called in the tax law 1099 work. Where you’re not an employee. You are a worker. And when you are a worker and not an employee, you are basically looked at under the tax code as self-employed.”
When you’re a full-time (W-2) employee for a company, your employer will withhold taxes from every paycheck. So the IRS is getting money from you throughout the year.
That’s not the case if you’re self-employed. Hence the need for quarterly estimated payments.
If you fit into one of these categories, you must pay quarterly estimated taxes:
- Freelancers, contractors and otherwise self-employed*
- Business owner^
- Some investors with realized capital gains
- Other non-wage earnings (examples: rental income, retirement income, lottery winnings, alimony payments, profits from selling a house and more)
- Some W-2 employees#
*Only if you expect to owe the IRS $1,000+ or make $400 in self-employed income for the year.
^Only if you expect to owe $500+ to the IRS for the year.
#Only if your paycheck withholdings don't fully cover your tax liabilities (if you still expect to owe the IRS $1,000+). Or if your withholding plus refundable credits equal less than 90% of your tax bill or 100% of your liability last year, whichever is smaller.
What’s Self-Employment Tax?
When you’re a full-time employee, your company withholds money from your paycheck for taxes. You’ll also notice line items on your paystub for Social Security and Medicare.
If you’re self-employed, the U.S. government still expects you to contribute to those big-ticket government programs. So you’ll owe what’s called “self-employment tax” (SE). This is something you pay outside of federal income taxes.
The self-employment tax rate is 15.3% — 12.4% for Social Security and 2.9% for Medicare. High earners may owe an additional 0.9% for Medicare.
“If you’re new to it, you’ve got to know that you pay more tax as a self-employed individual than you would if you were working for somebody else getting W-2 income,” Clark says. “So you have to pay double Social Security tax, what’s called SE tax. And so you’re paying a big tax bill.”
Clark’s Advice: Don’t Wait Until Tax Day To Pay Estimated Quarterly Taxes
If the IRS expects you to pay estimated quarterly taxes, but you haven’t yet followed the protocol, you don’t have to wait until you file your annual 2024 tax return.
If you pay your estimated taxes for Q1, Q2 and Q3 on the Q3 deadline of Sept. 16, 2024, for example, you’ll stop accruing interest on the underpayment penalties you face from Q1 and Q2.
“Better late than never,” Clark says.
Most people don’t make the Q1 quarterly estimated tax payment, Clark also pointed out, because the deadline falls on the same day that you must submit your annual tax return.
“I wanted to tell you now in August about getting money together to make the Sept. [16] estimate at least to cover some of the tax burden that’s building that’s accumulating interest,” Clark says.
“So yeah, it would’ve been better if you made the two prior payments. But at least make one in September. And then don’t wait until April 15 of next year. Make another estimate in January on your self-employed work.”
One Way To Reduce Your Self-Employment Tax Burden
Don't like the monetary burden of paying quarterly estimated taxes? Clark offers an alternative strategy: contribute to a SEP IRA. Typical for the self-employed and small-business owners, SEP IRA contributions reduce the self-employed income you have that's subject to tax.
“The SEP is really simple to set up. The paperwork takes about a minute to fill out. You do it with one of my favorite children. You know, one of the low-cost companies like Schwab, Vanguard, Fidelity,” Clark says.
“You can set up a SEP. And you don’t have to fund it until next year for this year. But it reduces your tax burden, which is so ugly, on side work and self-employment income.”
Final Thoughts
If you’ve blown off paying estimated quarterly taxes in the past, it’s much more expensive for you to do so now. The current IRS interest rate on underpayment penalties for those taxes? 8%.
Make sure you’re aware of your tax liability if you’re making money outside of a full-time, W-2 position.
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