The IRS announced that it is waiving the estimated tax penalty for many taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year.
The IRS is generally waiving the penalty for any taxpayer who paid at least 85% of their total tax liability during the year through federal income tax withholding, quarterly estimated tax payments or a combination of the two. The usual percentage threshold is 90% to avoid a penalty. (IRS Notice 2019-11)
The move addresses concerns expressed by various parties. A July 2018 Government Accountability Office (GAO) report projected that nearly 30 million taxpayers will owe money when they file their 2018 personal income tax returns due to underwithholding. A wide range of changes from the Tax Cuts and Jobs Act (TCJA) caused many taxpayers to be underwithheld.
A recent letter to the IRS from U.S. Senator Ron Wyden (D-OR) noted that millions of taxpayers would face unexpected tax bills and penalties. He wrote: “It seems unavoidable that millions of taxpayers who are expecting critical tax refunds will instead owe taxes” when they file.
The American Institute of CPAs and the National Conference of CPA Practitioners, in separate letters to the IRS, also asked the tax agency to forgo imposing penalties related to certain underpayments and under-withholding due to the TCJA, which was enacted in December 2017.
The waiver computation announced by the IRS on January 16 will be integrated into commercially available tax software and reflected in the forthcoming revision of Form 2210, “Underpayment of Estimated Tax by Individuals, Estates, and Trusts,” as well as its instructions.
This relief is designed to help taxpayers who were unable to properly adjust their withholding and estimated tax payments to reflect changes under the TCJA.
“We realize there were many changes that affected people last year, and this penalty waiver will help taxpayers who inadvertently didn’t have enough tax withheld,” said IRS Commissioner Chuck Rettig. “We urge people to check their withholding again this year to make sure they are having the right amount of tax withheld for 2019.”
The updated federal tax withholding tables, released in early 2018, largely reflected the lower tax rates and the increased standard deduction that are part of the new law. In general, that meant taxpayers had less tax withheld in 2018 and saw more in their paychecks.
However, the IRS explained that “withholding tables couldn’t fully factor in other changes, such as the suspension of dependency exemptions and reduced itemized deductions.” As a result, some taxpayers could have paid too little tax during the year, if they didn’t submit a properly-revised W-4 withholding form to their employers or increase their estimated tax payments. The IRS conducted an extensive outreach and education campaign throughout 2018 to encourage taxpayers to do a “Paycheck Checkup” to avoid a situation where they had too much or too little tax withheld when they file their tax returns.
“Although most 2018 tax filers are still expected to get refunds, some taxpayers will unexpectedly owe additional tax when they file their returns,” the IRS stated.
Because the U.S. tax system is pay-as-you-go, taxpayers are required, by law, to pay most of their tax liability during the year — rather than at the end of the year. This can be done by either having tax withheld from paychecks or pension payments, or by making estimated tax payments.
Usually, a penalty applies at tax filing if too little is paid during the year. Normally, the penalty wouldn’t apply for 2018 if tax payments during the year met one of the following tests:
- The person’s tax payments were at least 90% of the tax liability for 2018, or
- The person’s tax payments were at least 100% of the prior year’s tax liability, in this case from 2017. However, the 100% threshold is increased to 110% if a taxpayer’s adjusted gross income is more than $150,000 ($75,000 if married and filing separately).
For waiver purposes only, the IRS relief lowers the 90% threshold to 85%. This means that a taxpayer won’t owe a penalty if he or she paid at least 85% of his or her total 2018 tax liability. If the taxpayer paid less than 85%, then he or she isn’t eligible for the waiver and the penalty will be calculated as it normally would be, using the 90% threshold.
When it comes to withholding, the IRS wants taxpayers to check their situation again for 2019. This is especially important for anyone who faces an unexpected tax bill when they file a 2018 return this filing season. It’s also an important step for those who made withholding adjustments last year or had a major life change. You want to make sure the correct tax is still being withheld.
Who Could Have a Tax Season Surprise?
Those most at risk of having too little tax withheld from their pay include:
- Taxpayers who itemized in the past but now take the increased standard deduction,
- Two-wage-earner households,
- Employees with non-wage sources of income, and
- Taxpayers with complex tax situations.
To help get withholding right in 2019, an updated version of the agency’s online withholding calculator is now available on the IRS website. To access it, go to: https://www.irs.gov/individuals/irs-withholding-calculator.
The IRS previously announced that this year’s tax season starts on January 28. Although the IRS won’t begin processing 2018 returns until that date, your tax advisor can accept and prepare returns before then and answer any questions you have about your situation.