The law of unintended consequences has never been more evident than in the IRS’s efforts to fix the estimated tax problem caused by the Tax Cuts and Jobs Act (TCJA). This filing season it became apparent that many taxpayers had under withheld on their 2018 taxes, which can cause a big problem. If a taxpayer withholds or pays estimated taxes in an amount that is less than 90% of what they owe, they are subject to an estimated tax penalty, which is like an interest charge on their underpayment.
Much of the 2018 under withholding that occurred was not the taxpayers’ fault. Taxpayers usually rely on their employers to use IRS tables to calculate the proper amount. However, there are some indications that the IRS withholding tables issued after the tax bill passed were not accurate. The General Accountability Office (GAO) warned last July that 21% of taxpayers – or about 30 million people – were not withholding enough taxes from their pay in 2018.
Who is at Risk?
The many changes to the tax Code made by TCJA made it difficult for taxpayers and their advisors to accurately predict their 2018 liability. Those most at risk of having too little tax withheld from their pay include taxpayers who itemized in the past but now take the standard deduction, as well as two-wage-earner households, employees with non-wage sources of income and those with complex tax situations, according to the IRS.
As tax filing season kicked off, the IRS realized it had to address the high estimated tax penalties faced by unwitting taxpayers. In January, the IRS lowered the threshold to 85% of tax liability. Now they have lowered the threshold further to 80%. This means that if a taxpayer withheld or paid estimated taxes of at least 80% of their eventual tax liability during 2018, they will not owe a penalty. If the taxpayer paid less than 80%, the penalty will be calculated as it normally would be using the 90% threshold.
Estimated Tax Penalty Rules at a Glance
Taxpayers face an estimated tax penalty if they do not withhold or make estimated tax payments of:
Taxpayers are not penalized if they owe less than $1,000 in tax. Also note there are special, more beneficial rules for farmers and fishermen.
Estimated tax penalties operate like interest on the tax underpayment, with rates that are set by the IRS each year. The rate in 2018 was 5%. The 2019 rate is 6%.
Pursuing a refund
Haven’t yet filed? Taxpayers who have not yet filed their 2018 tax return may request waiver of the estimated tax penalty by filing Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts. This form should be attached to a taxpayer’s Form 1040.
Already paid the penalty? Taxpayers who have already paid the penalty but qualify for this expanded relief may claim a refund by filing Form 843, Claim for Refund and Request for Abatement.
Do a ‘Paycheck Checkup’
“We heard the concerns from taxpayers and others in the tax community, and we made this adjustment in an effort to be responsive to a unique scenario this year,” said IRS Commissioner Chuck Rettig. “The expanded penalty waiver will help many taxpayers who didn’t have enough tax withheld. We continue to urge people to check their withholding again this year to make sure they are having the right amount of tax withheld for 2019.”
Taxpayers can use the IRS’s Withholding Calculator to check if they are having enough withheld or are paying enough in estimated taxes. Accurate withholding can protect taxpayers from an unexpected tax bill or penalty at tax time next year.
There are many factors that go into projecting tax liability and a taxpayer’s circumstances can change during the year. The best route is to consult with your Frazier & Deeter tax advisor to get expert advice on your tax pre-payment strategy.