The Tax Cuts and Jobs Act of 2017 made numerous changes to the tax code, leaving many Americans confused about how to respond and ultimately unsure about their total 2018 tax burden as they file their returns this spring. On Friday, the IRS acknowledged in effect that it was harder to follow the rules last year, and said the agency would relax the penalty for not withholding enough from paychecks or quarterly estimated payments in 2018.
Along with the new law, the IRS made changes to withholding tables last year. The Treasury Department initially estimated that those changes could have given as many as 90% of workers a pay bump by withholding less in taxes from each check. However, that bump came at a price: many taxpayers wound up getting more during the year only to find that they owe money this spring. In other words, they hadn't had enough taken out in taxes last year.
“We’re seeing more and more people under-withheld,” Craig Wild, managing partner at tax and accounting firm Wild, Maney & Resnick, told Money earlier this year.
This is an issue because you're supposed to pay the taxes you owe over the course of the filing year. If you earn a salary or wages, those taxes come out of your paychecks; if you're a freelancer or work on a contract basis, you make estimated quarterly payments. To keep people from deliberately underpaying during the year, the IRS essentially sets a floor on how much you can underpay, after which you'll get dinged with an underpayment penalty. Ordinarily, that floor is set at 90% of what you owe, or at 100% to 110% of your tax obligation the previous year, depending on your income.
But 2018 was not an ordinary year for taxpayers, and the IRS has acknowledged as much with two modifications to the formula. Back in January, the agency increased that 10% buffer to 15%, and late last week, announced that it was once again lowering the threshold for penalty-free underpayment, this time to 80% of your tax liability.
IRS Commissioner Chuck Rettig said in an announcement that the expanded penalty relief was "an effort to be responsive to a unique scenario this year."
The change is being integrated into commercial tax-prep software, and the IRS's forthcoming revision to the instructions for Form 2210, which covers underpayment of estimated tax. (Here's the form). For taxpayers who already filed and who qualify for this penalty waiver, the IRS has these instructions: Fill out Form 843 and include the statement “80% waiver of estimated tax penalty” on Line 7. Unfortunately, even if you e-file, you'll have to claim this waiver the old-fashioned way and mail it in, since this form can't be filed electronically.
Since this was a limited-duration relaxation of the rules, you'll definitely want to use this IRS calculator to determine your correct withholdings for this filing year. (This tool was available last year, but the complexity of the new law, along with the scope of the changes, made it harder for people to use it accurately.) The tool can help verify that enough taxes are being withheld from your paychecks and instruct you to file an adjusted W-4 form with your employer if you're paying too little.
Taxpayers with the highest risk of underpayment include "taxpayers who itemized in the past but now take the increased standard deduction, as well as two-wage-earner households, employees with non-wage sources of income and those with complex tax situations," according to the agency.