If your 2018 federal income tax withholding and estimated tax payments came in under your actual tax liabilities for the year, you may qualify for a break from the IRS as it’s now waiving underpayment penalties for taxpayers who fall into this category. The IRS waiver recognizes that federal income tax changes brought about by the Tax Cuts and Jobs Act (TCJA) made it difficult for some taxpayers to properly calculate withholding amounts for their paychecks as well as amounts to include in their quarterly estimated 2018 tax payments. The IRS waiver aims to self-correct for those taxpayers who find themselves navigating either situation.
TCJA’s Impact on Individual Taxpayers
Once employers made the appropriate adjustments to employees’ earnings based on the IRS’ revised withholding tables, many taxpayers saw greater amounts of income in their 2018 paychecks. The new withholding tables represented the TCJA’s increase in the standard deduction, suspension of personal exemptions, and changes in tax rates and brackets. Review the significant changes enacted by the TCJA for individual taxpayers.
Under the new act, standard deduction amounts have nearly doubled over 2017 amounts – jumping to $12,000 for single filers and $24,000 for married couples, filing jointly. Personal exemptions, which taxpayers used to be able to claim for themselves, their spouses, and any dependents, have also been eliminated. Finally, both the taxable income thresholds and tax rates for the seven income tax brackets have been adjusted.
The combination of these changes, along with the reduction or elimination of several popular tax deductions, may mean that some taxpayers will incur larger income tax bills for 2018 than they had experienced in years prior. Further complicating matters, the reduced availability of itemized deductions (or the suspension of personal exemptions) are not reflected in the tables.
Taxpayers who choose to itemize, for example, will be limited to deducting no more than $10,000 for the aggregate of their state and local property taxes and sales or income taxes. Taxpayers who itemize can also only deduct mortgage interest on debt of $750,000 ($1 million for mortgage debt incurred on or before December 15, 2017) and aren’t allowed to deduct interest on some home equity debt.
On the positive side, the loss of some deductions and personal exemptions may be offset by higher standard deductions and expansion of family tax credits.
In light of the many TCJA changes, taxpayers were often unable to accurately gauge how these changes would impact their tax situation which put them at risk of underpayment penalties for 2018. The Government Accountability Office estimates that nearly 30 million taxpayers under withheld in 2017. As a result, these taxpayers will owe money when they file their personal income tax returns for 2018. Taxpayers at higher risk for under withholding include:
- Those who previously itemized but have opted to now take the standard deduction,
- Dual-wage-earner households,
- Employees that have nonwage sources of income, and
- Taxpayers with complicated tax situations.
Avoiding a Tax Underpayment Penalty
The IRS imposes a Section 6654 penalty if taxpayers fail to pay enough in taxes during the course of the year. A taxpayer can usually avoid the underpayment penalty if their tax payments covered at least 90% of the tax liability for the year or at least 100% of the tax liability for the prior year. If the taxpayer is a single filer and their adjusted gross income is in excess of $150,000 (or $75,000 if the taxpayers are married and filing a separate return), the 100% threshold is increased to 110%.
The underpayment penalty can usually be avoided, however, if, after subtracting their withholding and refundable credits, the taxpayer owes less than $1,000 in additional tax.
How the Waiver Works
The 90% threshold is lowered to 85% by the IRS’ waiver. In other words, if a taxpayer paid at least 85% of their total tax liability for 2018, a tax underpayment penalty will not be assessed by the IRS. However, the underpayment penalty will be calculated as it normally would be if less than 85% was paid.
Form 2210 (“Underpayment of Estimated Tax by Individuals, Estates, and Trusts”) must be filed with the taxpayer’s 2018 federal income tax return in order to request the waiver.
Plan Your 2019 Tax Strategy Now
Since the underpayment penalty waiver can only be applied to the 2018 tax year, the IRS strongly recommends that taxpayers review their withholding as early in 2019 as possible to avoid the under withholding pitfall. This is particularly important for taxpayers who ended up owing more income tax then they anticipated this past year.
If you have questions regarding the waiver or how to effectively plan for 2019 so you don’t find an unexpected tax bill waiting for you next April, contact your Untracht Early advisor.