The IRS requires you to pay in 90% of your current year tax liability or 110% of your prior year tax liability. These amounts are considered “safe harbor” payments. If you are a W-2 employee, the withholding from your wages will typically cover this safe harbor payment amount. If you are not a W-2 employee, you need to determine if it’d be best to pay in taxes based on 110% of your prior year tax liability or on 90% of your estimated current tax liability. If you don’t meet either of these thresholds, the IRS will assess underpayment penalties based on the amount of the underpayment and the time period when you were underpaid.
When the Tax Cuts and Jobs Act (TCJA) was passed at the end of 2017, the IRS was left scrambling to come up with new withholding tables for employers for 2018. In many cases, we saw taxpayers’ withholdings decrease more than their actual tax liability decreased. This left some with lower refunds than they were used to and others with a tax due. In some extreme cases, the withholding was so much lower they no longer hit the 90% safe harbor threshold and were subject to penalties.
In response, the IRS lowered the 90% threshold to 85% in January. Then they further reduced that threshold to 80% in late March. Tax software companies scrambled to integrate the new waiver computation into returns so that we could include a statement for relief of penalties. Unfortunately, some taxpayers had already filed their returns and had to file a claim for refund if they already paid penalties. Some of our clients who were able to include the statement for relief still received an incorrect notice from the IRS indicating they owed additional penalties!
Thankfully, the IRS appears to be trying to correct this issue by announcing they will automatically waive that penalty for all eligible taxpayers. This means there is no need to contact the IRS to request a waiver. If you have received a notice regarding an underpayment penalty or think you might have paid unnecessary penalties, please feel free to reach out to us.
-Chris Benson, CPA/PFS
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