The IRS has just announced it is waiving the estimated IRS underpayment penalty for millions of taxpayers who fell short this year.
It’s not every day the IRS decides to give millions of taxpayers a break, so savor the moment for now.
Now let’s break down what this means for the average taxpayer. The IRS charges a tax penalty if you don’t withhold enough of your taxes throughout the year. The usual threshold to trigger a penalty is 90%. The IRS just dropped it to 80%.
“We realize there were many changes that affected people last year, and this penalty waiver will help taxpayers who inadvertently didn’t have enough tax withheld. We urge people to check their withholding again this year to make sure they are having the right amount of tax withheld for 2019.”IRS Commissioner Chuck Rettig
Why were so many hit with an underpayment tax penalty in 2019?
The United States income tax system is a pay-as-you-go tax system. That means the IRS expects you to pay income tax as you earn or receive your income during the year. It’s similar to how you pay sales tax when you make a purchase, not at the end of the year.
The IRS charges penalties for all kinds of infractions. There are up to 140 reasons the IRS can charge you a penalty. Read this for an in-depth review of IRS tax penalties.
The most common IRS penalties include:
IRS withholding tables didn’t cover all scenarios
The withholding tables provided for 2018 didn’t fully factor in other changes, such as the suspension of dependency exemptions and reduced itemized deductions.
Some taxpayers could have paid too little tax during the year if they did not submit a properly-revised W-4 withholding form to their employer or increase their estimated tax payments.
Although most 2018 tax filers are still expected to get refunds, some taxpayers will unexpectedly owe additional tax when they file their returns.
Having trouble calculating how much you should withhold? The IRS has a free tool, the Withholding Calculator that makes it easy to figure out. It’s important to do this every year. But it is particularly important to revise your tax withholding rates in 2019 with all the changes we’ve seen in tax rates, deductions, and credits.
What is the maximum amount the IRS will waive?
The IRS waiver covers taxpayers who underpaid up to 20% of their total tax liability. For example, let’s say you owed $30,000 in taxes. You’re fine as long as you withheld $24,000 or more in taxes throughout the year. In other words, you need to withhold at least 80% of your total tax liability during the year through federal income tax withholding, quarterly estimated tax payments or a combination of the two.
Why did the IRS waive this tax underpayment penalty?
This relief is designed to help taxpayers who were unable to calculate their withholding and estimated tax payments accurately because of the changes under the Tax Cuts and Jobs Act (TCJA). The expansive tax reform law — enacted in December 2017 and released in early 2018 — reflected the lower tax rates and the increased standard deduction brought about by the new law. This generally meant taxpayers had less tax withheld in 2018 and saw more in their paychecks.
The IRS knows that offering tax relief in the form of tax penalty waivers and abatement can improve their ability to collect taxes.
How do you qualify for the underpayment penalty waiver?
Typically, the IRS gave taxpayers four reasons to request a waiver:
1) You didn’t make a required payment because of a casualty event, disaster, or other unusual circumstance and it would be inequitable to impose the penalty, or
2) You retired (after reaching age 62) or became disabled during the tax year or in the preceding tax year for which you should have made estimated payments. The underpayment was due to reasonable cause and not willful neglect.
3) Your income varied during the year and your penalty is reduced or eliminated when figured using the annualized income installment method.
4) Your penalty is lower when figured by treating the federal income tax withheld from your income as paid on the dates it was actually withheld, instead of in equal amounts on the payment due dates.
However, this year the IRS added a fifth one.
5) The underpayment was due to an inability to accurately calculate your estimated income tax payment due to the breadth of changes enacted by the tax reform.
In other words, the IRS acknowledges the tax reform changes made it more difficult to estimate taxable income.
“We realize there were many changes that affected people last year, and this penalty waiver will help taxpayers who inadvertently didn’t have enough tax withheld,” said IRS Commissioner Chuck Rettig. “We urge people to check their withholding again this year to make sure they are having the right amount of tax withheld for 2019.”
How do you apply for the IRS tax penalty waiver?
If you use tax software to prepare your taxes, don’t worry. The IRS gave them a heads up on this change and they already included it. I filed my taxes on Tuesday using TurboTax and requested the “tax reform” waiver. It worked like a charm.
If you are not using tax software, you can apply for the waiver by filing Form 2210.
How can you avoid the underpayment penalty in the future?
The IRS allows you to do this either through withholding or by making estimated tax payments. If you didn’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax.
Most taxpayers avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and refundable credits. Or if they paid at least 90% of the tax for the current year or 100% of what they paid last year.
The general rule is you can avoid the tax penalty if you make estimated tax payments in four equal amounts. However, if you receive income unevenly during the year, you may be able to vary the amounts of the payments. This can help you avoid or lower the penalty with the annualized installment method.
Andrew is the Content Director for SuperMoney, a Certified Financial Planner®, and a Certified Personal Finance Counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.