IRS Waives Penalty for Many Whose Tax Withholding and Estimated Tax Payments Fell Short in 2018

On January 16, 2019, the Internal Revenue Service (IRS) has announced it would waive the estimated tax penalty for those taxpayers that paid at least 85% of their 2018 tax liability through income tax withholding or quarterly estimated IRS payments. The usual threshold to avoid the underpayment penalty is 90% of current year tax. This year, the IRS has granted relief for 2018 tax returns to help those taxpayers unable to properly adjust their withholding or estimated payments to reflect changes made by the Tax Cuts and Jobs Act (TCJA) enacted in late 2017.

Tax law generally requires most taxpayers to pay tax on income as the income is earned throughout the year. These ‘pay-as-you-go’ tax payments are often made by withholding tax from paychecks or by making quarterly tax payments. Section 6654(a) of the Internal Revenue Code imposes a penalty when these payments are not timely or sufficient. Generally, this penalty would not be applied if the tax payments made during the year met one of the following two tests:

• The individual taxpayer’s tax payments were at least 90% of their 2018 tax liability OR
• The individual taxpayer’s tax payments were at least 100% of their prior year’s tax liability. Note: For taxpayers with adjusted taxable income of more than $150,000 (or $75,000 if married filing separately), the threshold is increased from 100% to 110% of the prior year’s tax liability.

The IRS published Notice 2019-11 on January 16, 2019 and lowered the 90% threshold to 85% for the 2018 tax year. The IRS has added this cushion to help taxpayers who inadvertently underpaid their taxes during the first year the TCJA went into effect. Because the TCJA prescribed lower tax rates, it meant lower withholding rates and thus more money in many people’s paychecks. Federal withholding tables were updated in early 2018 to reflect the lower tax rates and a higher standard deduction under the TCJA. However, the updated withholding tables could not factor in all the changes necessary to ensure an accurate estimation of tax liability, such as suspension of dependency exemptions and reduced itemized deductions. Consequently, some taxpayers will find that they have underpaid their 2018 tax liability. The IRS has therefore decided to help these taxpayers by lowering the penalty waiver threshold from 90% to 85%.

To request this waiver, the taxpayer must file IRS Form 2210, Underpayment of Estimated Tax for Individuals, Estates, and Trusts with the taxpayer’s 2018 income tax return. Taxpayers should complete Part I to determine if the waiver applies and then check the waiver box (Part II, Box A) and include “85% Waiver” with the tax return. Taxpayers that paid less than 85% will be ineligible for the waiver and will incur a penalty using the 90% threshold.

The IRS recognized the challenge to taxpayers in 2018 in accurately estimating their tax liability in light of the changes made by the TCJA. Taxpayers that paid at least 85% of their tax liability may obtain a waiver of the estimated payment penalty by filing Form 2210 with their 2018 tax returns. Taxpayers should also consult their tax advisors regarding their withholding and estimated payments for 2019 to ensure sufficient tax is withheld or paid.

For more information, please contact Stephen Gregory, Director, at Stephen.Gregory@CohnReznick.com or (959) 200-7021.