Taxpayers are required to pre-pay their taxes for any tax year through payroll withholding, estimated tax payments or a combination of the two. Employees and retirees generally accomplish this through withholding, and self-employed individuals and those with investment income by paying quarterly estimated payments.
The late-2017 passage of tax reform that became effective for 2018 and its radical changes added considerable confusion for taxpayers trying to determine how much they should prepay for 2018. This confusion was made worse because the existing W-4 that employees complete and that their employers use to determine the correct withholding was designed for prior law and does not work well with the new tax law. As a result, there has been ongoing concern by the IRS that many taxpayers will end up owing tax this year when they file their 2018 returns, even though they got a tax reduction due to the tax reform changes, simply because their pre-payments through withholding and estimated tax payments were not enough.
For most of 2018, the IRS was issuing alerts that taxpayers may be under-withheld because of tax reform and the fact the W-4 could no longer be relied upon to produce a correct withholding amount.
Taxpayers whose pre-payments are less than certain safe harbor amounts are penalized. Those safe harbors are:
- 90% of the current year’s tax liability; or
- 100% of the prior year’s tax liability (110% where the prior year AGI is over $150,000 ($75,000 if married and filing separate returns).
Recently several members of Congress have called upon the IRS to waive underpayment penalties for 2018. On January 16, 2019, although not waiving the penalties entirely, the IRS did change the current year safe harbor from 90% of the 2018 tax liability to 85%, providing a break for some taxpayers.
Even if you don’t meet one of the safe-harbor exceptions, a waiver of the penalty for 2018 may apply if you:
- Retired (after reaching age 62) or became disabled in 2017 or 2018.
- You did not make payments because of one of the following situations and it would be inequitable to impose the penalty:
b. Disaster, or
c. Other unusual circumstance.
There are two other exceptions to the penalty for 2018:
- If the total tax shown on your 2018 return minus the tax that was withheld is less than $1,000, you will not owe a penalty.
- If you had no tax liability in 2017, were a U.S. citizen or resident alien for all of 2017, and your 2017 return was for a full 12 months (or would have been had you been required to file), you won’t be charged an under-prepayment penalty.
In addition, where your tax liability and /or tax pre-payments were uneven, the penalty amount may be mitigated by figuring it on a quarterly basis.
If you have questions or would like to make sure your withholding and estimated payments are adequate for 2019, please give us a call.