The first year of the Tax Cuts and Jobs Act (TCJA) has caused confusion for both tax professionals and taxpayers. One of these areas of concern for taxpayers is withholding. An employee – a taxpayer who receives a paycheck and a W-2 at the end of the year – typically has taxes withheld by their employer from his or her paycheck. A self-employed taxpayer is required to make four quarterly installment payments of estimated taxes, in place of withholding.
While the TCJA reduced tax rates, it also removed exemptions and certain deductions, thereby increasing the amount of income that is taxed, leaving many taxpayers apprehensive about what they may owe on April 15. Further confounding matters was the release of the tax withholding tables under the new law, which came more than a month into the tax year under the old withholding regime. The new tables reduced withholding based on the tax rates, but did not take into account the reduction in deductions.
With penalties applicable for under-withholding, many were wondering if the Internal Revenue Service (IRS) would provide any leniency for taxpayers who did not satisfy their withholding requirements in the first year of the law. The IRS answered that question on Wednesday, January 16, with an announcement that the threshold for assessing a penalty would be reduced, but not by much. Generally, an individual taxpayer must withhold – or pay in estimated tax payments to the IRS – 100% (110% if the taxpayer’s adjusted gross income exceeds $150,000 for married filing jointly or $75,000 for separate or single filers) of his or her prior year tax liability OR 90% of his or her current year tax liability, in order to qualify for “safe harbor” protections and avoid a penalty for underpayment of estimated taxes. For this tax filing season, the IRS reduced the safe harbor withholding percentage to 85% of the current year tax liability. In other words, taxpayers who have paid at least 85% of their total 2018 tax liability to the IRS through withholding or estimated tax payments are exempt from the penalty for underpayment of estimated taxes.
This announcement comes on the heels of calls for leniency from the American Institute of CPAs and several members of Congress after the Government Accountability Office estimated that 30 million Americans did not withhold enough taxes in 2018. Senate Finance Committee chairman Chuck Grassley (R-Iowa) took the Senate floor just moments before the IRS issued its statement, calling for a waiver of penalties for those Americans who under-withheld in 2018. Grassley called for leniency, while also hedging against taxpayers “exaggerating” the effects of the new law on their withholding, noting that many of that 30 million would not have withheld enough even before the passage of the TCJA. The IRS certainly appears to have erred on the side of caution in only reducing the threshold to 85 percent.
For tax preparers, the IRS announced that the 2018 version of Form 2210, which is used to calculate the penalty, will be updated to reflect the reduced threshold and will be available in commercial tax preparation software for the filing season. See IRS Notice 2019-11 for more information.
If you need assistance addressing IRS penalties or determining the proper amount of withholding, Aronson’s tax controversy team can help. Please contact Patrick Deane or Larry Rubin at 301.231.6200.