Many federal employees who have, or in the process of filing their 2018 federal tax returns, are shocked by the amount that they owe to the IRS on their 2018 returns. To make matters worse, some of these individuals may be subject to an underpayment penalty.
This column discusses the IRS underwithholding penalty and what can be done to avoid the underwithholding penalty for 2019.
For 2018, individuals are subject to an underpayment penalty unless total federal income withholdings – these include income tax withholdings typically come from paychecks, pension payments, and IRA distributions and estimated payments made during 2018 equal the smaller of:
- 90 percent of the tax liability shown on the 2018 return, or
- 100 percent of the tax liability shown on the 2017 return (110 percent if the individual’s 2017 adjusted gross income (AGI) was over $150,000).
As many federal employees are discovering as they prepare their 2018 federal income tax returns, many employees had a significant underwithholding of federal income taxes during 2018. The Tax Cuts and Jobs Act of 2017 (TCJA), while reducing individual tax brackets also caused havoc among many employees with respect to determine the optimum number of federal tax withholdings to claim during 2018. The result has been significant balances due for many individuals who have already filed their 2018 federal income returns.
On March 22, 2019, the IRS provided additional expanded penalty relief for individuals whose 2018 federal income tax withholding and estimated tax payments turned out to be significantly short of their total tax liability for 2018. The IRS lowered the threshold required to qualify for this relief to 80 percent. Under the original relief announced on Jan. 16, 2019, the threshold was lowered to 85 percent. The usual percentage threshold is 90 percent to avoid penalty. This means that the IRS is now waiving the estimated tax penalty for any individual who paid at least 80 percent of their total federal tax liability during 2018 through federal income tax withholding ,by quarterly estimated tax payments, or a combination of the two.
IRS Form 2210 (Underpayment of Estimated Tax by Individuals) is used to calculate an individual’s underwithholding penalty. Once calculated on Form 2210, the underwithholding penalty is reported on Form 1040.
Note that Form 2210 does not have to be filed with one’s tax return and the penalty is not required to be calculated and reported on Form 1040. The IRS will calculate the penalty and bill the individual. No interest is charged on the penalty if the tax return was filed by the due date (April 15) and the penalty is paid by the date specified on the bill. There is also no tax preparer penalty for not reporting the penalty.
The IRS may waive the penalty in the case of a casualty, disaster, or other unusual circumstance. A waiver is also granted if an individual becomes disabled or retires after age 62 and the underpayment was due to a reasonable cause and not to willful neglect.
Changes in marital status
When an individual’s marital status changes from one tax year to the next, the exception to the underpayment penalty based on paying 100 percent (110 percent for high AGI individuals) of a prior year tax liability is computed as follows:
- Single to married filing joint return. The estimated tax payments for the joint return are based on the sum of the couple’s individual prior year tax liabilities. Their combined prior year AGI’s determine whether the 100 percent or 110 percent threshold applies.
- Joint to separate returns. If a joint return was filed in 2017 but not in 2018, then the first computation is the tax each spouse would have paid in 2017 based on their 2018 filing status. Then, multiply the tax shown on the 2017 joint return by the following fraction:
Individual’s tax on 2017 income based on 2018 filing status/sum of the spouse’s separate 2017 liabilities
The following example illustrates:
Larry and Darcy divorced in 2019. Their 2018 joint return showed taxable income of $150,000 and a federal tax liability of $24,000. Of the $150,000 taxable income, $120,000 was Darcy’s and $30,000 was Larry’s. Both Larry and Darcy want to make estimated tax payments for 2019, based on their 2018 tax liability to avoid an underpayment penalty. Each would calculate how much to pay in estimated tax payments during 2019 using the following table:
In other words, if Larry makes an estimated tax payment of $2,880 during 2019, he will avoid any underwithholding penalty when he files his 2019 income tax return. If Darcy makes an estimated tax payment of $21,120, then she will avoid any underwithholding penalty for 2019.