The Internal Revenue Service 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.
Because the U.S tax system is pay-as-you-go, taxpayers are required to pay most of their tax obligation during the year, rather than in one payment at the end of the year. This can be done by either having tax withheld from paychecks or pension payments or by making quarterly estimated tax payments. Usually a penalty applies at tax filing if too little was paid during the year. Normally, the penalty would not apply if the tax payments during the year met one of two tests: (1) the person’s tax payments were at least 90 percent of their tax liability for the year or (2) the person’s tax payments were at least 100 percent of the prior year’s tax liability (or 110 percent if the taxpayer’s adjusted gross income is above certain levels).
Under the new exception, the IRS is generally waiving the penalty for any taxpayer who paid at least 85 percent of their total tax liability during the year through withholding, quarterly estimated payments, or a combination of both. So, for example, if your tax liability for the year was $10,000 and your withholding and estimated tax payments totaled $8,800, under the old rules, you would be subject to the underpayment penalty since you did not pay at least 90 percent of the tax due. But under the new exception, you would not be subject to the underpayment penalty because you paid at least 85 percent of the tax due. If the taxpayer paid less than 85 percent, then they are not eligible for the waiver and the penalty will be calculated as it normally would.
The relief is designed to help taxpayers who were unable to properly adjust their withholding and estimated tax payments to reflect the changes under the Tax Cuts and Jobs Act enacted in December 2017. The IRS acknowledged that there were many changes that affected people last year as a result of the far-reaching tax reform, and the penalty waiver will help taxpayers who inadvertently did not have enough tax withheld.
We also urge everyone to check their withholding for 2019. This is especially important for clients now facing an unexpected tax bill when they file. It is also an important step for those taxpayers who made withholding adjustments in 2018 or had a major life change to ensure the right tax is still being withheld. 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, as well as two-wage-earner households, employees with nonwage sources of income, and those with complex tax situations.