A common tax penalty for self employed individuals is the underpayment penalty for not paying enough estimated taxes. The IRS requires that self-employed individuals must estimate their annual income tax a full year prior to actually knowing what that amount will be. It is very common for individuals to not estimate enough income tax and end up paying the penalty.
Typically, the IRS requires you to make equal payments on a quarterly basis throughout the year. If you realize that you have not paid enough early on in the year and you pay more in your next payment, you will still typically be hit with an underpayment penalty. Below are some ways to eliminate the risk of this underpayment penalty or to reduce the amount you will be charged for this penalty.
Figuring estimated taxes can be a hassle, but using the safe harbor method is the easiest way to avoid paying the penalty. Keep in mind that when using this method you can be stuck with a big tax bill at the end of the year if you significantly increase your income from one year to the next (but penalty free). To avoid a large tax bill at the end of the year, you will need to make voluntary payments in an amount greater than the minimum amount required.
This post was published on April 29, 2010