Personal Finance

A big tax deadline is just a week away. Here's what you need to know to avoid underpayment penalties

Key Points
  • People who pay their taxes on a quarterly basis have until Jan. 15 to give the IRS their final payment for 2019.
  • You generally have to pay at least 90% of your tax liability for 2019 in order to avoid an underpayment penalty.
  • While the IRS waived penalties for people who fell short of their tax liability on their 2018 tax return, it's not likely to be as forgiving this time around.

Whether you have a side hustle or you're running your own business, you're a week away from a major tax deadline.

Individuals who pay their estimated taxes every quarter — including independent contractors and members of partnerships — are expected to make their fourth and final payment for 2019 on Jan. 15.

The quarterly deadlines for the 2020 tax year are April 15, June 15, Sept. 15 and Jan. 15, 2021.

While employees have taxes withheld from their pay by their employer, people who run their own businesses are responsible for paying self-employment taxes and income taxes four times a year.

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This means entrepreneurs must crunch the numbers and see how their income and expenses will measure up, as well as figure out what they'll owe Uncle Sam.

"The fourth-quarter estimate is one of the more important quarterly estimates," said Thomas Neuhoff, CPA and senior associate at Henry & Peters in Tyler, Texas. "You have more information on the full calendar year at this point, compared to a second- or third-quarter estimate."

Avoiding a penalty

John Ewing | Portland Press Herald | Getty Images

To avoid an underpayment penalty from the IRS, you must pay at least 90% of the taxes owed for a given year — or 100% of the liability from the prior year.

If your adjusted gross income on the prior year's return exceeded $150,000, you're responsible for 110% of the tax liability.

Failure to pay the appropriate estimated tax can result in underpayment penalties.

Late-year surprises can leave taxpayers with more or less income than expected for the fourth quarter of 2019.

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"Sometimes we have independent contractors or people who work in real estate and work on commission, and they get a big year-end bonus or close a big deal close to year-end," said Neuhoff.

Similarly, large capital gains from a mutual fund you hold in a taxable account can affect estimates, too. Those funds typically distribute capital gains by selling underlying investments during the fourth quarter.

Your fourth-quarter estimate should consider this tax liability.

Don't expect a lighter touch

The Internal Revenue Services offices in Washington, D.C.
Adam Jeffery | CNBC

Some taxpayers were unable to pay the appropriate amount of tax during 2018, the first year under the Tax Cuts and Jobs Act.

The change to the tax code lowered individual income rates, nearly doubled the standard deduction and eliminated personal exemptions.

As a result, the IRS lowered the 90% tax threshold to 85% and then 80% for the 2018 tax year.

That year, if you paid at least 80% of what you owed, you avoided a penalty.

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Don't count on that relief for 2019.

The IRS recently made a round of updates to its tax withholding estimator, which you can use to figure out the amount of federal income tax held from your paycheck.

This calculator also considers self-employment income and investment income.

Making the appropriate tax payments over the course of the year can be the difference between getting a refund or owing the IRS taxes and penalties.