The chance you underwithheld taxes in 2018 may be higher than you think. A 2018 report by the Government Accountability Office (GAO) suggests that 21% of taxpayers, more than 30 million people, may owe taxes due to underwithholding in 2018. If you’re one of those people, you had until Jan. 15, 2019, to avoid a penalty with an estimated tax payment. If you missed that opportunity, there may still be good news. On Jan. 16, 2019, the IRS issued a waiver that may help people who missed the deadline avoid a penalty, provided they take appropriate action outlined below.
The GAO Report
Your employer is required to withhold taxes on your pay based on withholding tables provided by the Internal Revenue Service (IRS), but you can reduce the amount withheld by claiming withholding allowances. Historically, allowances have been based on personal exemptions, which no longer exist due to changes brought on by the Tax Cuts and Jobs Act (TCJA).
According to the GAO, the U.S. Treasury Department chose the same withholding allowance value ($4,150 for 2018) that would have existed under old tax law. This resulted in 30 million people underwithholding in 2018, vs. 27 million who would have underwithheld under previous tax law.
Why Underwithholding Is a Problem
The U.S. tax system operates on a “pay-as-you-go” (sometimes called “pay as you earn”) basis, meaning you are required to withhold or pay estimated taxes during the tax year. The elimination of the personal exemption, changes to withholding tables brought on by the TCJA—and the fact that taxpayers were encouraged, but not required, to file an updated W-4 Form—may have resulted in underwithholding of taxes for millions of taxpayers.
People Who Should Be Concerned
According to the GAO, a married taxpayer with two children who earns $180,000 annually, including $20,000 from nonwage income—and who itemizes deductions—is a likely candidate for underwithholding. You may also find yourself subject to under these circumstances.
- You itemized in the past, but now plan to take the higher standard deduction.
- You are part of a two-wage earner household with no children or children age 17 or above.
- You have self-employment or other nonwage income.
- You received year-end bonuses, stock dividends, or capital gains.
- You owe the alternative minimum tax or tax on unearned income of minors.
- You realized a profit from property sales.
- You live in a high-tax state and are losing part of your state and local tax (SALT) deductions.
- You have significant unreimbursed employment-related expenses no longer deductible under TCJA.
- You have gambling winnings for which taxes were not withheld.
If any of these apply to you—and you also failed to update your withholding in 2018—the risk of underwithholding is even greater.
When the Penalty Kicks In
Normally an underpayment penalty may apply if the amount withheld (or paid through estimated taxes) is not equal to the smaller of 90% of the taxes you owe for 2018 or 100% of the taxes you owed for the 2017 tax year. If a penalty applies, it is typically 0.5% of the amount owed for each month that amount was unpaid.
The IRS waiver, issued Jan. 16, 2019, drops the threshold to 85%. In other words, if the amount withheld including estimated tax payments is equal to or exceeds 85% of the taxes you owe for 2018 (or 100% of the taxes you owed for the 2017 tax year) ,the penalty is waived.
Additional Available Waivers
The penalty may also be waived under these circumstances.
- You owed no taxes in 2017.
- You have tax liability (minus payments already made) for this year of less than $1,000.
- You missed an estimated payment due to a casualty, disaster, or other unusual circumstance.
- You retired after reaching age 62 and that was the cause of the underwithholding.
- You became disabled during the previous or current tax year and failed to make estimated payments for that reason.
- You had any other situation in which underpayment was not due to willful neglect on your part.
Even if you don’t qualify for a waiver, you may qualify for a reduced penalty in certain circumstances, including a change in marital status or substantial income realized late in the year.
What You Should Do
Determine whether you underwithheld taxes in 2018. Although the IRS won’t begin accepting tax returns until Jan. 28, you can start getting ready now. The 2018 version of Form 1040 and instructions have already been posted on the IRS website along with many supplemental forms and schedules with more being added each day.
According to the IRS the Jan. 16 waiver will be integrated into commercially-available tax software as well as Form 2210 (used by taxpayers who underwithheld taxes). Make sure you update your tax software or obtain the latest tax forms before preparing your return. Software companies and tax professionals will begin accepting and preparing returns ahead of the Jan. 28 date. Free File is also available now.
File Form 2210
If you underwithheld taxes in 2018 you must file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts with your 2018 income tax return no later than April 15, 2019 (for 2019 taxes, it will be April 15, 2020). Complete Part I of Form 2210 and the included work sheet and instructions to determine whether a waiver applies in your case. If the Jan. 16 waiver applies, check the waiver box in Part II and include the statement “85% Waiver” with your return. This waiver is in addition to any other waiver for which you may qualify.
If a Waiver Does Not Apply
If neither the Jan. 16 waiver or any other waiver applies, you will likely owe a penalty. In some cases, the IRS will figure the penalty for you. In other cases, you must use Form 2210 to figure the penalty yourself. See Form 2210, instructions and work sheet for more information.
The Bottom Line
Just because the final deadline for estimated tax payments for 2018 has passed does not mean you owe a penalty even if you underwithheld on your taxes last year. Check your eligibility for the Jan. 16 revised threshold waiver as well as other waivers for which you might qualify. For more on the Jan. 16 waiver see Notice 2019-11, posted on IRS.gov.
If you underwithheld last year, whether you qualify for a waiver or not, check your withholding for 2019 to avoid this problem in the future. Remember that the 85% threshold will likely only apply for 2018 taxes and will return to 90% when you file in 2020. Use the updated online IRS Withholding Calculator to help you adjust withholding amounts.