The Internal Revenue Service has seen a surge in recent years of taxpayers underpaying their estimated taxes and paying the penalty for it.

The number of taxpayers who were penalized increased nearly 40 percent from 7.2 million to 10 million filers between 2010 and 2015, according to IRS data analyzed by The Wall Street Journal, or nearly 33 percent from almost 7.5 million to nearly 10 million filers between fiscal years 2007 and 2016, according to a similar analysis by USA Today. Both reports relied on figures from Table 17 of the IRS’s Data Book for 2015 and 2016, according to IRS officials.

“If you’re looking at notices issued in FY 2016, which are primarily 2015 returns, you see roughly about 10 million notices, and total assessments of about $1.3 billion,” said IRS spokesman Eric Smith. “Then there were some abatements too.”

The abatements were about $118 million for approximately 145,000 taxpayers in fiscal 2016.

It isn’t clear why more taxpayers and their accountants are underestimating the quarterly tax payments, but the rise of the so-called “gig economy,” or “sharing economy,” could be one factor.

“The summer of most years is prime time for our notice project on assessing estimated tax penalties,” said Smith. “A lot of people who are affected by the penalty are getting notices.”

A sample copy of the CP 30 notice and more information about responding to it is available here, he added. However, he pointed out that many taxpayers can qualify for exceptions to avoid the underpayment penalties, and the annualized income installment method can help.

“For starters, the annualized income method is the one that will help a person if they received all of their income during the last part of the year and made a fourth-quarter payment to cover it,” said Smith. “Likewise, it will reduce the penalty if a person made no payments at all.”

The IRS has information on its website that can help guide taxpayers and preparers through the method. The publication also covers how to use the method for reducing or eliminating any penalty.

“If perhaps you receive income unevenly throughout the year, and if you receive a substantial portion of it late in the year, there are waiver options for those who are in casualty and death situations, or if they recently retired or became disabled and are now getting a surprise this year,” said Smith. “They can either change their withholding or make sure they have adequately taken care of an estimated tax payment. We know that in the middle of the year you can do something to make sure you don’t face this situation next year or at the very least that any penalty is minimized. You can do that in a couple of different ways. Everybody’s situation is different, but there are definitely a lot of people who have a substantial amount of outside income from the gig economy, but at the same time are working for an employer.”

In that case, they can increase their withholding and adjust the number of withholding allowances being claimed. If that’s still not enough, they can tell their employer to withhold a flat dollar amount for each pay period, he suggested.

“For many people that can help resolve the issue,” said Smith. “For somebody who is not working for an employer or doesn’t have a spouse working for an employer, you’re looking at making quarterly payments. There are things people can do now, but the trend line indicates people don’t realize they could make estimated tax payments, or avoid a penalty situation by changing their withholding. Because of the number of people affected, it is particularly important to let people know they have options at this point.”

The gig economy has opened up new ways for people to make some extra money, but just because they don’t receive a tax form from a company like Uber or Airbnb, that doesn’t mean their earnings are tax free.

“They are in a situation where they have to think about how they’re doing this as a side business,” said Smith. “If they’re trying this as a side gig, maybe look at doing quarterly payments, so they don’t get an unpleasant surprise at the end of the year.”

Avoiding Penalties

To avoid unpleasant surprises in the future, there are some steps taxpayers and preparers can take. "Looking ahead, 10 million taxpayers now face the estimated tax penalty each year," Smith advised. "Here’s how to avoid it for 2017. Most of those affected can easily reduce or eliminate it for the coming year by increasing their withholding or estimated tax payments for the rest of the year. Usually, the penalty applies when you pay too little in during the year. The penalty calculation is based on the interest factor used by the IRS. To avoid it, most people need to make sure they have at least 90 percent paid in during they year. Exceptions apply to some people, including farmers, fishers and those who base their payments on last year’s tax. There is also an exception for those who receive income unevenly during the year, and reasonable cause waivers are available to casualty and disaster victims, and those who recently became disabled and recent retirees."

People who receive a penalty notice or had a big balance due when they filed for 2016 may want to consider increasing their withholding by filling out a new W-4, Smith noted. Similarly, recipients of pensions and annuities can make this change by filling out Form W-4P and giving it to their payer.

"In either case, you can typically increase your withholding by claiming fewer allowances on your withholding form," said Smith. "If that’s not enough, also ask employers or payers to withhold an additional flat dollar amount each pay period. The Withholding Calculator on IRS.gov can help. By the way, there’s also a voluntary withholding option for those who receive Social Security benefits, unemployment compensation and certain other government payments, but the process is a little different and more restrictive. Use Form W-4V. For some, withholding of any kind is not an option. In that case, use Form 1040-ES. Payments can be made electronically through IRS Direct Pay or Treasury’s EFTPS [Electronic Federal Tax Payment System] or, of course, by check. Payments are due April 15, June 15, September 15 and January 15, unless any of these fall on a weekend or holiday."

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Michael Cohn

Michael Cohn

Michael Cohn, editor-in-chief of AccountingToday.com, has been covering business and technology for a variety of publications since 1985.