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The chance you underwithheld on your 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 have until Jan. 15, 2019, to avoid a penalty with an estimated tax payment.
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 will result in 30 million people underwithholding in 2018 versus 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
In general 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 this year or 100% of the taxes you owed last year. If a penalty applies, it is typically 0.5% of the amount owed for each month that amount was unpaid.
When the Penalty Is Waived
The penalty may 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 Now
Time is short, so immediate action is called for if you suspect you may be subject to a penalty.
Prepare – Even though you can’t file yet, you can start getting ready. The IRS has already posted the 2018 Form 1040 and instructions on the IRS website. Many supplemental forms and schedules are also available with more being added each day.
Use the IRS Withholding Calculator – The withholding calculator, along with a copy of last year’s tax return and your most recent pay stubs, will help you determine whether your taxes have been underwithheld by telling you how many allowances you should have claimed this past year. The tool is designed for wage earners but can also be helpful if you receive pension or annuity income.
Review Form 1040-ES – If you have income not subject to withholding, from self-employment, for example, Form 1040 ES helps you figure your estimated tax payments for the year. A quick review of this form can help you determine whether your estimated payments have been enough.
When and How to Pay
If you discover that your withholding or estimated payments have been too low, the deadline to make one final payment to the IRS for 2018 is Jan. 15, 2019. You have a variety of ways to pay estimated tax. You can pay online, by phone or from a mobile device, by mailing a check or in person at a local retail IRS partner. Visit the IRS payments web page for a full list of ways to pay. For detailed information on withholding and estimated tax, see IRS Publication 505.
The Bottom Line
Don’t wait to find out whether you may owe a penalty for underwithholding. Calculate the amount you are likely to owe minus the amount already withheld or paid through estimated taxes. If it looks like you might be subject to an underpayment penalty, make a payment before Jan. 15 to be compliant. In the past, major changes to tax law have included a provision that waives underpayment penalties during the first year of implementation. The TCJA contains no such provision.
Published by investopedia.com