More than one in five taxpayers with wages probably had too little money withheld for taxes last year, according to the Government Accountability Office.
Among the most likely are taxpayers with wages of $180,000, at least $20,000 of non-wage income and itemized deductions; taxpayers with gambling winnings; those with unreimbursed employment-related expenses; and taxpayers who can’t claim their full state and local taxes as itemized deductions.
The IRS usually fines those who still owe more than 10% of their tax liability when they file their tax returns.
But in a fit of generosity, it is altering the rules this year because of the tax reform passed at the end of 2017 and the delayed recalculation of withholding tables to reflect these changes. Some taxpayers will be spared a fine if they had just 85% of the amount owed withheld, rather than 90%. But the waiver doesn’t apply to everyone. Here’s what you need to know.
Who qualifies for this one-time waiver of the fine?
Taxpayers who paid at least 85% (it is usually 90%) of their tax liability qualify for the waiver. Obviously, the greater the taxpayer’s tax liability, the more this is worth.
This special provision only applies to your 2018 tax return. So if you haven’t filed your tax returns for 2017 or earlier, the underpayment percentage for those years is 90%. Moreover, you will probably owe interest and penalties for failing to file your return in a timely way.
Are there other exceptions to the penalty?
Several other criteria can exempt a taxpayer from the underwithholding penalty. These are:
• The taxpayer owes $1,000 or less; or
• The taxpayer didn’t have a tax liability for 2017 and was not required to file a tax return; or
• The taxpayer with an adjusted gross income of $150,000 or less ($75,000 if married and filing separately) withheld at least 100% of the 2017 tax liability; or
• The taxpayer who had an adjusted gross income of more than $150,000 ($75,000 if married and filing separately) withheld at least 110% of their 2017 tax liability.
To state the obvious, there is no underwithholding penalty if a taxpayer is getting a refund.
In addition, the underwithholding penalty can be waived in part or all if the IRS determines that:
• The taxpayer retired in the prior or current year after reaching age 62 or became disabled and the underpayment is due to reasonable cause (and not willful neglect); or
• The underpayment is due to a casualty, disaster or other unusual circumstance, and it would be inequitable to impose the penalty.
However, the waiver in these two cases is not automatic. A taxpayer must complete Form 2210, check the appropriate box requesting the waiver and include the requested supporting documentation.
Who is likely to get hit with the penalty?
Most taxpayers should avoid this penalty given the reduction in the tax rates and expanded tax-rate brackets for most taxpayers. However, some were unable to properly adjust their withholdings. For example, taxpayers with unearned income such as interest and dividends and two wage-earner families are more likely to have underwithheld this past year. Obviously, the best defense to the underwithholding penalty is satisfy one of the exception rules.
it’s too late to make a quarterly tax payment (that deadline was Jan. 15), but if you’re worried that you might face a penalty, see whether you qualify for a tax-deductible IRA contribution. The deadline for 2018 contributions is April 15.
How can I calculate my withholding amount next time?
Most tax software programs let taxpayers estimate their tax liability for the coming year, whether they then need to send in quarterly tax payments and, more important, how much. In addition, the IRS has a free, user-friendly withholding calculator on its website. However, the calculator is only as good as the information you put into it. The better you estimate your income for next year, the better the calculator will estimate your tax liability. Or consult a qualified tax preparer for advice.
Anthony P. Curatola is the Joseph F. Ford Professor of Accounting at Drexel University’s LeBow College of Business and editor of the Taxes column for Strategic Finance.