The chance you under-withheld taxes last may be higher than you think. A 2018 report by the Government Accountability Office (GAO) suggests that a fifth of taxpayers, more than 30 million people, may owe taxes due to underwithholding last year. 

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 to avoid a penalty, provided they take appropriate actions outlined below.

Key Takeaways

  • Nearly 1 out of 5 taxpayers may have owed taxes due to under-withheld taxes as part of the Trump tax law changes. 
  • Many people are coping with under-withheld taxes is the fact that the U.S. Treasury Department did not update the personal withholding amount to reflect changes in the tax law.
  • Likely candidates for under-withholding include married taxpayers with multiple children, those who have non-wage income, and those who are self-employed. 
  • Depending on the amount of the under-withholding, and whether or not you compensate for it before the deadline, under-withholding penalties can apply. 
  • There are a variety of waivers you can qualify for to avoid this penalty. 

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.

  • If you are interested in resources to learn more about how changes to taxes may affect you, there are two documents that can help, both provided by the IRS. Publication 5307, titled Tax Reform: Basics for Individuals and Families and Publication 5318, titled Tax Reform: What’s New for Your Business are great places to start. 

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 under-withholding 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 non-wage 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 circumstances.
  • 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. The 2018 version of Form 1040 and instructions are still on the IRS website along with many supplemental forms and schedules with more being added each day.

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 2019 income tax return no later than April 15, 2020. 

Complete Part I of Form 2210 and the included worksheet and instructions to determine whether a waiver applies in your case. 

If a waiver does not apply, 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 worksheet 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 wavier as well as other waivers for which you might qualify.

If you underwithheld last year, whether you qualify for a waiver or not, check your withholding 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.