It is designed to limit underpayment and corresponding underpayment penalties related to uneven payments when a taxpayer's income fluctuates throughout the year. It's a choice, however it is considered as being withheld evenly throughout the year regardless of when it was actually withheld, so you can use the best option for your situation.
The IRS calculates this penalty by first figuring out how much you should have paid each quarter. Then, it multiplies the difference between what you paid and what you should have paid by the underpayment rate for that period. The IRS determines that rate for each quarter of the year. For 2023, the rates are:
- 7% for Quarter 1 (January-March),
- 7% for Quarter 2 (April-June),
- 7% for Quarter 3 (July-September), and
- 8% for Quarter 4 (October-December)
For example, if you owed $20,000 in taxes during the first quarter of 2023, then you should have paid $5,000 per quarter. In the first quarter, you paid only $4,000. Your underpayment penalty for that quarter would be $17.50 ($5,000 - $4,000 = $1,000 x 7%/4 (a quarter)).
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