When you fail to make the total tax payment for a certain year, the chances are high that you will need to pay a quarterly tax penalty rate. Underpayment of estimated quarterly tax can create a big hole in your budget, which is why you need to watch out for the penalties.
With America's tax system, it might feel overwhelming to figure out exactly how much you have to pay. Calculated incorrectly, you might not be able to file for tax return. This guide will teach you everything you need to know in order to avoid tax liability.
The penalty rate for estimated taxes in 2020 is 5%. This rate remained unchanged until the 1st of April, 2021, when the penalty became 3%. The IRS changes the penalty amount quarterly throughout the year, which is why you may want to pay attention to this.
For example, many people may meet the due date, but fail to notice that the penalty rate changed in the last year. If they are lucky enough, they overpay the tax and no longer owe anything. However, if they underpay the estimated tax payments, they will have to face an estimated income tax penalty.
Estimated tax payments are due quarterly throughout the year. Payments must be done by the following dates; otherwise, you risk having to pay a penalty:
Depending on the circumstances, the IRS may decide to delay certain deadlines. Moreover, the restrictions caused by the COVID-19 pandemic may have affected some of the deadlines.
For example, the individual income tax filing that was due by April 15th, 2021, was postponed to May 15th, 2021. Be sure to carefully watch for any potential announcements from the IRS. You could also pay your entire estimated tax payment at one time when 1099s are due.
Tax payments may also be done monthly instead of quarterly if that is your preference. This option is good if you wish to add a fixed amount to your tax budget.
People gaining their income through self-employment are not the only ones who have to pay estimated tax payments. Anyone may have to pay these taxes by the end of the tax year. The following payments that aren't subjected to withholding will be subjected to tax liability on income tax:
With that in mind, not all businesses need to make estimated tax payments. If your business meets at least one of the following conditions, then you will be exempt from tax payments:
If you owe estimated tax, then you need to pay a close eye to the deadlines for estimated tax payments. If you miss by even one day, you'll be penalized for underpayment of estimated tax.
The penalties and interest will depend on how late you are on making your payment. If you miss a day, it is recommended you make your tax payments as soon as possible. The tax penalty will increase with every passing day in which it remains unpaid.
As one may know, the United States works on a pay-as-you-go system. As a result, taxpayers will make the tax payments based on the money that they have at hand. Very often, they make estimated tax payments or pay their taxes by means of withholding. So, what happens when you pay quarterly taxes late?
Since people are required to calculate their taxes themselves, they may end up not paying enough or simply withholding a tax payment throughout the year. If this happens, you may be liable for penalties. The IRS refers to this as "Penalty for Underpaying Estimated Taxes."
The amount of the tax penalty will depend on how much you owe in estimated taxes. The more you wait, and the more money you owe, the higher the penalty will be.
If you receive self-employment income from your small business, then you need to use Form 1040-ES from the IRS to calculate your estimated tax. By following the steps correctly, you should be able to avoid underpayment of estimated tax.
If the payments are not calculated properly, then the estimated tax penalty will begin to grow with every missed due date. With every day that passes, the interest rate on the penalty may grow - but at the same time, it will also depend on the laws of the IRS.
To put it simply, the IRS will use a formula to calculate the estimated tax penalty. This formula is based on how much underpayment amount there was for that quarter in particular.
People with self-employment income generally have a federal short-term rate plus 3%. In this case, however, the penalty rate can change from one quarter to another, in accordance with that federal rate.
For example, up until the second quarter of 2020, the federal short-term rate was a total of 5%. Still, starting with the third quarter, the rate dropped to only 3%. In the same year, there were two different rates for the estimated tax penalty to be paid.
With each installment, the penalty rate will be calculated separately. This may mean that you still owe a penalty, even if you already made shortfall tax payments later in the quarter. In the end, you may make a correct payment for the whole year, but receive a penalty for underpaying in that specific quarter.
The method can change from quarter to quarter, which is why you need to follow the IRS page. On Form 2210, you may find several methods for calculating the penalty amount based on the underpayment amount that you owe.
Calculating the estimated tax penalty can be quite a complicated procedure - and very often, people also make mistakes with how much they owe. This is why, in most cases, the IRS will calculate the underpayment of estimated tax for you instead.
You will be sent a bill so that you won't have to calculate those payments yourself. All you have to do is let a blank space on the penalty line and skip filing Form 2210.
If you succeeded in filing the income tax by April 15th, then you won't be charged any interest rate for the penalty. It will be considered that you paid the amount of tax by the due date the IRS set for you.
The rate for the underpayment penalty in 2021 is between 3% and 5%, depending on the filing. The (a)(2) underpayment penalty rate is 3%, whereas the (c)(1) rate is 5%. The underpayment trends are lower when you compare them to the previous years.
Usually, a penalty is incurred whenever someone fails to make a full year's tax payment. In many cases, the penalty will only increase with every passing day. However, there are certain cases in which the penalty for the tax may be waived. It may apply to you if you meet the following requirements:
In certain circumstances, as long as there is reasonable cause, the IRS may also decide to waive your penalty. Here are the circumstances in which this may happen:
In most cases, not-knowing neglect that had a reasonable cause is accepted by the IRS. There are a few other exceptions as well, such as for farmers, household employers, and fishermen, all of which you may find in Publication 505 released by the IRS.
Obviously, the best way for you to avoid a penalty is to make sure you pay quarterly taxes on time in the first place. Pay your estimated income taxes year-round by their due date, and there shouldn't be any problem.
If you are an employee and have your taxes withheld by the company you are working at, then you may use Form W-4 in order to change the withholding rights. Ideally, this should be done at the beginning of the year; the earlier, the better.
This way, you may do the calculations yourself and avoid any further penalties. Form W-4 can also catch any errors from the previous tax filing process, particularly when you seem to owe more tax money than you're withholding.
If you are self-employed, then your taxes won't be withheld from your self-employed income. You will have to do these taxes yourself. Usually, to avoid any penalties, you might want to file for taxes four times a year, by the IRS deadline.
When making your estimated tax, you might want to factor in the penalty amount as well. Make sure to pay by the deadline, even if you are letting the IRS do the calculations for you. If not, simply use form 1040-ES to calculate the tax payments.
If you reach the end of the tax year and you withheld the total tax amount, then you won't have to worry about being penalized. When the year's tax season comes around, to be sure, you may want to get a hold of form 2210. This way, you will be able to calculate your income tax so that you incur no estimated penalties.
Taxes can be quite complex, specifically where the estimated tax penalty rate is involved. Ideally, if you are not completely certain, then you may want to discuss matters with your tax advisor.
Remember that these taxes change by the quarter, so keep a close eye on what the IRS is doing. If the rate changes, you need to take it into account so that you aren't given a tax penalty.
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?