As overall interest rates have crept up over the past few years, so has the interest rate assessed by the IRS on taxpayers that owe significant taxes with the filing of their personal income tax return. Going back to the first quarter of 2022 that underpayment interest rate was 3%. Gradually increasing over the past 2 years, the assessed IRS rate on underpayments of taxes is now at 8% for the fourth quarter of 2023. For taxpayers who generally saw their Underpayment of Estimated Tax Penalty assessed in the amount of $500 on their tax return when a large tax balance was owed resulting from not paying estimated taxes in prior years, that penalty quite possibly may jump to more than $1,200 under a similar tax shortfall scenario in 2023, an increase of more than 250%.
Paying a fourth quarter estimated tax will help reduce an assessed penalty, but not by very much if nothing was paid in quarters 1, 2 and 3. Assuming you currently have the funds for the taxes to be owed set aside for the current year, one alternative to avoid the possible assessment of this tax shortfall penalty is to take advantage of the 60-day rollover rule. A taxpayer is allowed to take a distribution from an IRA or employer plan and roll over the funds within a 60-day period of time. For a taxpayer facing a tax shortfall and looking to avoid an Underpayment of Estimated Tax Penalty assessment, they can take the IRA or retirement plan distribution in the amount of the projected tax shortfall and withhold the entire amount of the distribution for federal and state taxes – thus, getting the tax shortfall paid into the IRS and state by December 31, 2023. Although the taxpayer has 60 days to roll over the full amount of the gross distribution (distribution amount before withheld taxes), we recommend rolling over the funds within a week or two to be sure the rollover isn’t forgotten. One last caveat to note, the IRS limits taxpayers to making an IRA-to-IRA rollover only once per any 12-month period of time.