Last year, the General Accounting Office (GAO) warned that millions of taxpayers could owe more in taxes come tax time. Without proper planning (and a withholding checkup), those taxpayers could be surprised to find out that they not only owe taxes, but also underpayment penalties. To ease the burden on taxpayers, the Internal Revenue Service (IRS) has advised that penalty relief may be available.
Here’s what happened. The Tax Cuts and Jobs Act (TCJA) introduced many changes beginning in 2018, including caps on state and local tax deductions, a zeroed-out personal exemption amount, and the elimination of reimbursed job expenses. Additionally, since Congress passed the law in December of 2017, new withholding tables were not available to employers until mid-January, and some employees didn’t see a switch in withholding until mid-February. (You can see the withholding tables here and find out more about updating your form W-4 here.)
The combination of new rules, new withholding tables, and even new tax forms has been confusing, leading some tax professionals, including the American Institute of CPAs (AICPA), to call for relief from IRS. (You can read the letter from the AICPA, which downloads as a pdf, here.) The result? The IRS has advised that they will waive underpayment penalties (tax geeks will recognize these as section 6654 penalties) so long as withholding and estimated tax payments total at least 85% percent of the tax shown on the return for the 2018 taxable year.
While we joke about writing big checks on Tax Day, taxpayers typically pay their taxes during the tax year through a combination of withholding and estimated payments made in four installments. The check to IRS at the end of the year accounts for any shortfall. In most cases, if you don’t pay—through that combination of withholding and estimated payments—at least 90% of the tax that you owe or 100% of the tax that you owed in the prior year (the percentage is 110% if your adjusted gross income on that return was at least $150,000), you may owe a penalty.
Exceptions and waiver provisions apply (of course, since this is tax law). Most taxpayers know, for example, about the $1,000 rule: There’s generally no penalty if you owe less than $1,000 in tax. But in addition to those specific exceptions, the Secretary of the Treasury has authority to waive penalties under section 6654(e)(3)(A) if “by reason of casualty, disaster, or other unusual circumstances the imposition of such addition to tax would be against equity and good conscience.” For 2019, the “other unusual circumstances” involve the administration of the TCJA.
So what does this mean? In simple terms, the 90% threshold for estimated payments and withholding has been reduced to 85%.
Still confused? Here’s an example:
Let’s say that your tax liability for the year was $10,000 and your withholding and estimated payments totaled $8,700. Under the old rules, you would be subject to the underpayment penalty since you didn’t pay at least 90% of the tax due. But under the new exception, assuming you otherwise qualify, you would not be subject to the underpayment penalty because you paid at least 85% of the tax due.
To request the penalty relief, file federal form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts (the 2017 version downloads here as a pdf) together with your 2018 income tax return. Complete Part I and the worksheet included in the form instructions to determine if the waiver applies. If the waiver applies, check the waiver box at Part II, Box A and include the statement “85% Waiver” with your return:
If the waiver doesn’t apply (and you don’t qualify for any other exception), you may be subject to an underpayment penalty.
But don’t stop there. If you didn’t withhold enough, you’ll want to make some changes on your form W-4 for 2019. IRS Commissioner Chuck Rettig has said, “We urge people to check their withholding again this year to make sure they are having the right amount of tax withheld for 2019.” (For more on form W-4, click here.)
If you’re still scratching your head, you’re not alone. Withholding can be confusing and IRS assistance is limited since phone lines are down and taxpayer assistance offices are closed during the shutdown. My best advice? Check with your tax professional for more information.